<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 21, 1999.
REGISTRATION NO. 333-79863
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 3 TO
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
MGC COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
NEVADA 4813 88-0360042
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
3301 N. BUFFALO DRIVE KENT F. HEYMAN, ESQ.
LAS VEGAS, NEVADA 89129 3301 N. BUFFALO DRIVE
(702) 310-1000 LAS VEGAS, NEVADA 89129
(ADDRESS, INCLUDING ZIP CODE, (702) 310-1000
AND TELEPHONE NUMBER, INCLUDING (NAME, ADDRESS, INCLUDING ZIP CODE,
AREA CODE, OF REGISTRANT'S AND TELEPHONE NUMBER, INCLUDING
PRINCIPAL EXECUTIVE OFFICES) AREA CODE, OF AGENT FOR SERVICE)
</TABLE>
------------------------
COPIES TO:
<TABLE>
<S> <C>
ROBERT B. GOLDBERG, ESQ. RALPH J. SUTCLIFFE, ESQ.
ELLIS, FUNK, GOLDBERG, LABOVITZ & DOKSON, P.C. KRONISH LIEB WEINER & HELLMAN LLP
3490 PIEDMONT ROAD, N.E., SUITE 400 1114 AVENUE OF THE AMERICAS, 46TH FLOOR
ATLANTA, GEORGIA 30305 NEW YORK, NEW YORK 10036
(404) 233-2800 (212) 479-6000
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: The sale of
securities under this Registration Statement will begin as soon as practicable
after the effective date of this Registration Statement.
If the only securities being registered on this Form are being offered in
connection with dividend or interest reinvestment plans, please check the
following box: [ ]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
- ---------------
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
- ---------------
If the delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED TO BE REGISTERED PER SHARE OFFERING PRICE REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.001 par value........ 14,599(1) $29.00(2) $423,371 $117.70(3)
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Excludes 6,411,250 shares which were previously registered, as reflected in
Amendment No. 1 to this Registration Statement. An additional 14,599 shares
are being registered with this Amendment No. 3.
(2) This represents the average between the high and low sales prices of Common
Stock on the Nasdaq Stock Market on July 19, 1999.
(3) Excludes registration fee of $41,700.00 which was previously paid with
respect to 6,411,250 shares previously registered under this Registration
Statement.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THE REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED JULY 21, 1999
PRELIMINARY PROSPECTUS
5,587,695 SHARES
MGC COMMUNICATIONS, INC.
COMMON STOCK
------------------------------
[MGC LOGO]
This is a public offering of 5,587,695 shares of common stock of MGC
Communications, Inc. We are selling 5,000,000 shares of common stock and the
selling stockholders identified in this prospectus are selling up to 587,695
shares of common stock. We will not receive any of the proceeds from the shares
of common stock sold by the selling stockholders.
The underwriters have an option to purchase a maximum of 838,154 additional
shares of common stock from us to cover over-allotments of shares.
Our common stock is traded on the Nasdaq National Market under the symbol
"MGCX." On June 30, 1999, the last reported sales price was $26.00 per share.
SEE "RISK FACTORS" BEGINNING ON PAGE 9 TO READ ABOUT RISKS THAT YOU SHOULD
CONSIDER BEFORE BUYING SHARES OF OUR COMMON STOCK.
------------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS
APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------------
<TABLE>
<CAPTION>
PER
SHARE TOTAL
----- -----
<S> <C> <C>
Public offering price....................................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to us............................ $ $
Proceeds, before expenses, to the selling stockholders...... $ $
</TABLE>
------------------------------
The underwriters are severally underwriting the shares being offered in this
prospectus. The underwriters expect to deliver the shares against payment in New
York, New York on , 1999.
------------------------------
BEAR, STEARNS & CO. INC.
GOLDMAN, SACHS & CO.
ING BARINGS
THE DATE OF THIS PROSPECTUS IS , 1999.
<PAGE> 3
PROSPECTUS SUMMARY
This summary contains basic information about us and this offering. Because
it is a summary, it does not contain all of the information that you should
consider before investing. You should read the entire prospectus carefully,
including the section entitled "Risk Factors," our financial statements and the
notes related to our financial statements. References in this prospectus to
"we," "us," "our" or "MGC" mean MGC Communications, Inc. and its subsidiaries,
unless the context otherwise requires. The term "you" refers to prospective
investors in the common stock. Certain terms we use in this prospectus to
describe our network and its components are explained in the section entitled
"Business -- Network Architecture and Technology." Unless otherwise specified,
all information in this prospectus assumes no exercise of the underwriters'
over-allotment option.
MGC COMMUNICATIONS
We are a growing communications company currently offering local dialtone,
long distance and other voice services to small business and residential
customers. We expect to offer bundled voice and high-speed data services using
digital subscriber line ("DSL") technology in some of our markets later this
year.
- We have one of the largest collocation footprints, with 233 central
office collocation sites providing us access to approximately 12.8
million addressable lines, including an estimated 4.0 million small
business lines, all as of the end of the first quarter of 1999.
- We currently deliver our services in the metropolitan areas of Atlanta,
Chicago, Las Vegas, southern Florida and selected areas of southern
California, including Los Angeles and San Diego.
- We have interconnection agreements with five incumbent local exchange
carriers: Ameritech, BellSouth, GTE, PacBell and Sprint.
- At the end of the first quarter of 1999, we had 79,332 customer lines
sold, of which 65,147 lines were in service.
- During 1999, we plan to continue expanding our network to over 300
central office collocation sites providing access to approximately 17
million addressable lines.
- During 2000, we plan to expand into approximately 20 new markets and add
over 250 central office collocation sites.
- We have developed a sophisticated, proprietary operations support system
designed to manage all aspects of our business, including timely and
accurate provisioning to place our customers on our network.
We were one of the first competitive local exchange carriers to implement a
"smart-build" strategy, building and owning the intelligent components of our
network -- switches and collocation facilities -- while leasing unbundled loops
and transport from other carriers. We believe this "smart-build" strategy has
allowed us to quickly establish a large collocation footprint at a comparatively
low cost while maintaining control of the access to our customers. Having
executed our "smart-build" strategy, we are well-positioned to serve the growing
demand from small business customers for communications services.
The rapid growth of the Internet has fueled demand from small businesses
for access to high-speed data services. To meet this growing demand, we intend
to overlay DSL technology into our existing network to provide a bundled voice
and high-speed data solution over a single copper unbundled loop. This will be
accomplished by installing DSL equipment in our host switch sites, collocation
sites and at our customers' sites. On average, DSL technology increases the
transport
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<PAGE> 4
capacity of standard copper telephone lines by 24 times. This increased capacity
will allow us to meet the growing demand for high-speed data services and to
deliver multiple voice telephone lines to a customer using a single unbundled
loop which we lease from the incumbent local exchange carrier. By using a single
unbundled loop to deliver a bundled voice and high-speed data product, we expect
to significantly reduce the per line costs of provisioning customer lines and
the associated recurring leased transport and unbundled loop costs. These
savings should allow us to offer a value-priced package of services to our
customers. Several of our customers are testing our bundled voice and high-speed
data product, which is delivered via DSL. We plan to offer this product to small
businesses in select markets later this year.
MARKET OPPORTUNITY
We believe we have a significant market opportunity as a result of:
- the impact of the Telecommunications Act of 1996;
- the needs of small businesses for integrated communications solutions;
- the growing market demand for high-speed digital communications; and
- the emergence of DSL technology.
THE MGC SOLUTION
We believe that we offer an attractive communications solution to small
business and residential customers. Key aspects of our solution include:
- Simple, Competitive Flat Rate Packages. We offer our customers simple,
value-priced solutions for their communications requirements, all on a
single bill. Today we offer high quality basic communications products
and services, including local dialtone, custom calling features, long
distance and dial-up Internet access, at discounted prices.
- "One-Stop" Communications Solutions. Our flat rate, bundled packages
eliminate the need for our customers to decide among a broad array of
communications options. Through the implementation of DSL technology, we
expect to offer a "one-stop" communications solution for our customers,
which will include our current communications products bundled with high-
speed data service. Our customers will have a single point of contact for
a complete package of services, eliminating the need for our customers to
manage multiple vendors.
- Service Reliability. We are able to offer our customers a high degree of
service reliability through efficient, timely execution of provisioning
unbundled loops due to our mature relationships with five incumbent local
exchange carriers. We believe the introduction of DSL technology will
enable us to further improve our service reliability by simplifying the
provisioning process. Moreover, our customer service center is staffed to
respond promptly to customer inquiries 24 hours a day, seven days a week.
BUSINESS STRATEGY
Our goal is to become a leading national communications provider of bundled
voice and data solutions to the small business market. We intend to implement
the following strategies in an effort to achieve our goal:
- address the greatest percentage of our targeted customers as quickly as
possible through our continued rapid service rollout;
- expand significantly our direct sales force to provide greater sales and
marketing coverage of the small business customers in our extensive
network footprint;
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<PAGE> 5
- deploy a DSL solution to position ourselves to be one of the first
providers of bundled voice and data services to small business customers
in our target markets;
- employ a capital efficient network strategy to maximize return on our
invested capital;
- continue to enhance and increase the capacity of our sophisticated
operations support system to support our expanding operations;
- control access to our customers by placing them directly on our network;
- effectively manage the provisioning process to transfer new customers
from the incumbent local exchange carriers' networks to our network in an
accurate and timely fashion; and
- provide superior service and customer care.
RECENT DEVELOPMENTS
In May 1999, we issued 5,277,779 shares of Series B Convertible Preferred
Stock to Providence Equity Partners III L.P., JK&B Capital III L.P., Wind Point
Partners III, L.P. and their affiliates. We received $47.5 million in gross
proceeds from the issuance of the Series B Convertible Preferred Stock. The
Series B Convertible Preferred Stock is convertible into common stock on a
one-for-one basis. See "Description of Securities."
As of June 30, 1999, our total access lines in service increased by 24,388,
or 37% from March 31, 1999, to 89,535 and our total access lines sold and
installed increased from March 31, 1999 by 30,148, or 38% to 109,480 as of June
30, 1999. As of June 30, 1999, our central office collocation sites increased to
248 providing us access to approximately 13.7 million addressable lines. We
spent $8.7 million for capital expenditures during second quarter 1999. During
second quarter 1999, the number of our sales personnel increased from 66 to 85
as of June 30, 1999.
The following information reflects our second quarter 1999 results and
balance sheet data as of June 30, 1999:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1999 JUNE 30, 1999
------------------ ----------------
STATEMENTS OF OPERATIONS: (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
Revenues.................................................. $ 11,485 $ 19,886
Cost of operating revenues................................ 10,506 18,989
--------- ---------
Gross profit.............................................. 979 897
Selling, general & administrative......................... 9,197 16,924
Depreciation & amortization............................... 4,182 7,666
--------- ---------
Operating loss............................................ (12,400) (23,693)
Non-operating expense..................................... (3,137) (6,056)
--------- ---------
Net loss.................................................. (15,537) (29,749)
Accrued preferred stock dividend.......................... (729) (729)
--------- ---------
Net loss applicable to common stockholders................ $ (16,266) $ (30,478)
========= =========
Basic and diluted loss per share of common stock.......... $ (0.93) $ (1.76)
========= =========
Basic and diluted weighted average shares outstanding..... 17,475 17,341
EBITDA(1)................................................. $ (8,218) $ (16,027)
</TABLE>
5
<PAGE> 6
<TABLE>
<CAPTION>
AS OF
JUNE 30, 1999
SELECTED BALANCE SHEET DATA: --------------
(IN THOUSANDS)
<S> <C>
Cash, cash equivalents & investments........................ $ 84,355
Restricted cash............................................. 29,950
Property & equipment, net................................... 132,683
Long-term debt.............................................. 157,485
Series B Convertible Preferred Stock........................ 46,500
Stockholders' equity........................................ 32,319
</TABLE>
- ---------------
(1) EBITDA consists of earnings before interest, income taxes, depreciation and
amortization. EBITDA does not represent funds available for management's
discretionary use and is not intended to represent cash flow from
operations. EBITDA should not be considered as an alternative to loss from
operations as an indicator of our operating performance or as an alternative
to cash flows as a measure of liquidity. In addition, EBITDA is not a term
defined by generally accepted accounting principles and, as a result, the
measure of EBITDA may not be comparable to similarly titled measures used by
other companies. We believe that EBITDA is often reported and widely used by
analysts, investors and other interested parties in the communications
industry. Accordingly, we are including this information to permit a more
complete comparison of our operating performance relative to other companies
in the industry.
PRINCIPAL EXECUTIVE OFFICES
Our principal executive offices are at 3301 N. Buffalo Drive, Las Vegas,
Nevada 89129. Our telephone number is (702) 310-1000.
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<PAGE> 7
THE OFFERING
Common stock offered by
us(1)......................... 5,000,000 shares
Common stock offered by the
selling stockholders(2)....... up to 587,695 shares
Common stock to be outstanding
after this offering(3)...... 22,685,434 shares
Use of proceeds............... Capital expenditures related to the
purchase and installation of DSL and other
communications equipment and for general
corporate purposes, including working
capital to fund our expanding sales and
marketing efforts.
Nasdaq National Market Symbol
for Common Stock.............. MGCX
- -------------------------
(1) The underwriters have an over-allotment option to purchase an additional
838,154 shares solely to cover over-allotments.
(2) This represents the estimated number of shares that we expect the selling
stockholders to sell in the offering.
(3) The number of shares outstanding excludes:
- shares of common stock which may be issued upon the exercise of
outstanding stock options (options to purchase 2,111,650 shares were
outstanding as of July 20, 1999 at a weighted average exercise price of
$7.38 per share);
- 509,721 shares of common stock which may be issued upon the exercise of
outstanding warrants with an exercise price of approximately $.02 per
share (warrants to purchase up to 15,870 of these shares may be exercised
by selling stockholders including shares in this offering);
- the conversion of the 5,277,779 shares of Series B Convertible Preferred
Stock outstanding, which shares may be converted into shares of common
stock on a one-for-one basis; and
- any shares which may be issued if the underwriters exercise their
over-allotment option.
7
<PAGE> 8
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
<TABLE>
<CAPTION>
QUARTER ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------ ---------------------
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
(AUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues.............. $ 1 $ 3,791 $ 18,249 $ 2,846 $ 8,401
Cost of operating revenues...... 305 3,928 17,129 2,371 8,483
Selling, general and
administrative expenses....... 841 6,440 17,877 2,562 7,727
Loss from operations............ (1,554) (7,851) (21,995) (2,954) (11,293)
OTHER FINANCIAL DATA:
EBITDA(1)....................... $(1,145) $(6,577) $(16,757) $(2,087) $ (7,809)
Capital expenditures............ 3,659 22,641 97,101 10,671 15,240
OPERATING DATA (END OF PERIOD):
Total access lines in service... 50 15,590 47,744 20,924 65,147
Central office collocation
sites......................... 9 25 207 29 233
Switches in service............. 1 3 7 3 7
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
--------------------------
ACTUAL AS ADJUSTED(2)
-------- --------------
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents and investments available-for-sale
(excluding restricted investments)........................ $ 55,307 $224,657
Restricted investments...................................... 39,929 39,929
Property and equipment, net................................. 128,136 128,136
Total assets................................................ 237,553 407,068
Long-term debt.............................................. 157,286 157,286
Series B Convertible Preferred Stock........................ -- 46,500
Stockholders' equity........................................ 48,649 171,499
</TABLE>
- ---------------
(1) EBITDA consists of earnings before interest, income taxes, depreciation and
amortization. For the year ended December 31, 1996, EBITDA excludes a charge
of $355,000 related to the one-time write-off of purchased software. EBITDA
does not represent funds available for management's discretionary use and is
not intended to represent cash flow from operations. EBITDA should not be
considered as an alternative to loss from operations as an indicator of our
operating performance or as an alternative to cash flows as a measure of
liquidity. In addition, EBITDA is not a term defined by generally accepted
accounting principles and, as a result, the measure of EBITDA may not be
comparable to similarly titled measures used by other companies. We believe
that EBITDA is often reported and widely used by analysts, investors and
other interested parties in the communications industry. Accordingly, we are
including this information to permit a more complete comparison of our
operating performance relative to other companies in the industry.
(2) Gives effect to the issuance of 5,277,779 shares of Series B Convertible
Preferred Stock in May 1999 and to this offering based on an assumed
offering price of $26.00 per share.
8
<PAGE> 9
RISK FACTORS
You should carefully consider the following factors, in addition to other
information in this prospectus, before purchasing the securities being offered.
The risks and uncertainties described below are not the only ones facing our
company. Additional risks and uncertainties of which we are unaware or currently
think are inmaterial may also impair our business operations.
If any of the following risks actually occur, our business, financial
condition or results of operations could be materially adversely affected. This
could cause the trading price of our common stock to decline and you could lose
all or part of your investment.
OUR BUSINESS MODEL IS STILL EVOLVING AND WE HAVE A LIMITED OPERATING HISTORY
We have a very limited operating history. As a result, there is limited
historical financial information about us upon which to base an evaluation of
our future prospects or performance. We began providing local telephone services
in December 1996 in Nevada. Since then, we have begun providing local telephone
services in Atlanta, Chicago, southern Florida and selected areas of southern
California, including Los Angeles and San Diego. In February 1998, we began
offering long distance services. We expect to continue to increase the size of
our operations in the future and to commence offering high-speed data and
Internet services. Because some of our services are new and a large portion of
our resources will be dedicated to our high-speed data and Internet services, it
is difficult to evaluate our business and our revenue and income potential is
uncertain.
We are depending on the success of our high-speed data and Internet
services to accelerate our revenue growth. If our business does not evolve as we
expect, we will likely grow at a significantly slower pace than would be the
case if our high-speed data and Internet services are successful. In addition,
there is no historical basis for estimating the number of customers or the
amount of revenues our high-speed data and Internet offerings will generate or
for determining whether we will be able to compete successfully in the
communications industry. If our high-speed data and Internet services do not
evolve as we expect or we are unable to compete in the communications industry,
it is likely the price of our stock will be adversely affected.
WE EXPECT OUR LOSSES TO CONTINUE
We recorded net losses of $14.2 million in the first quarter of 1999, $32.1
million in 1998, and $10.8 million in 1997. In addition, we had negative cash
flow from operations of $.6 million in the first quarter 1999, $24.2 million in
1998 and $4.5 million in 1997. We expect to record significant net losses and
generate negative cash flow from operations for the foreseeable future. We
cannot assure you we will achieve or sustain profitability or generate
sufficient positive cash flow from operations to meet our planned capital
expenditures, working capital and debt service requirements. In the absence of
favorable operating results, we could face substantial liquidity problems and
might be required to seek additional financing through the issuance of debt or
equity securities. However, we could be unsuccessful in obtaining additional
financing on acceptable terms when needed.
WE WILL NEED SIGNIFICANT ADDITIONAL FUNDS THAT WE MAY NOT BE ABLE TO OBTAIN
We require significant amounts of capital to fund the development and
expansion of our business and services as well as operating costs and debt
service. We expect to fund our capital requirements through existing resources,
debt or equity financing and internally generated funds. We expect continued
expansion of our business may require raising substantial additional equity
and/or debt capital. However, our future capital requirements will depend upon a
number of factors, including factors not within our control, such as competitive
conditions, government regulation and capital costs. In addition, the terms of
our outstanding debt and preferred stock restrict our ability to incur
additional debt or issue additional preferred stock. We cannot assure you we
will be successful in
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<PAGE> 10
raising sufficient debt or equity financing on acceptable terms. If we cannot
generate or otherwise access sufficient funds, we may be required to delay or
abandon some of our future expansion plans. This would likely have a negative
impact on our growth and our ability to compete in the communications industry.
OUR SUBSTANTIAL DEBT CREATES FINANCIAL AND OPERATING RISK
As of March 31, 1999, we had approximately $157.3 million total outstanding
debt. Our level of debt could have important consequences to you, including the
following:
- a substantial portion of our cash flow from operations will be dedicated
to paying principal and interest on our debt, thereby reducing funds
available for other purposes;
- our significant amount of debt could make us more vulnerable to changes
in general economic conditions or increases in prevailing interest rates;
- our ability to obtain additional financing for working capital, capital
expenditures, acquisitions, general corporate purposes or other purposes
could be impaired; and
- we may be more leveraged than some of our competitors, which may result
in a competitive disadvantage.
OUR DEBT COVENANTS AND PREFERRED STOCK TERMS COULD LIMIT HOW WE CONDUCT OUR
BUSINESS
Our debt indenture contains covenants that restrict our ability to:
- incur additional debt;
- pay dividends and make other distributions;
- prepay subordinated debt;
- make investments and other restricted payments;
- create liens;
- sell assets; and
- engage in transactions with affiliates.
The terms of our Series B Convertible Preferred Stock require us to obtain
the approval of the holders of a majority of the Series B Convertible Preferred
Stock if we take specified actions. Please see "Description of
Securities -- Series B Convertible Preferred Stock."
Our future financing arrangements will likely contain similar or more
restrictive covenants. As a result of these restrictions, we may be:
- limited in how we conduct our business;
- unable to raise additional debt or equity financing to operate during
general economic or business downturns; and
- unable to compete effectively or to take advantage of new business
opportunities.
This may affect our ability to generate revenues and make profits.
Our failure to comply with the covenants and restrictions contained in our
indentures and other financing agreements could lead to a default under the
terms of these agreements. If a default occurs, the other parties to these
agreements could declare all amounts borrowed and all amounts due under these
agreements and under other instruments that contain provisions for
cross-acceleration or cross-default due and payable. If that occurs, we cannot
assure you we would be able to make payments on
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<PAGE> 11
our debt, meet our working capital and capital expenditure requirements, or find
additional alternative financing. Even if we could obtain additional alternative
financing, we cannot assure you it would be on favorable or acceptable terms.
OUR SUCCESS DEPENDS ON THE EFFECTIVENESS OF OUR MANAGEMENT AND WE ARE SEEKING TO
MAKE CHANGES TO OUR MANAGEMENT TEAM
Our business is managed by a small number of key management personnel, the
loss of some of whom could have a material adverse effect on our business. We
believe our future success will depend in large part on our ability to attract
and retain highly skilled and qualified personnel. None of our key executives is
a party to a long-term employment agreement and we do not maintain key man
insurance on our officers.
We are in the process of seeking a new chief executive officer and/or chief
operating officer. We cannot assure you that the new senior officer will be
effective in managing our company or will successfully work with our existing
management team, nor can we assure you that we will be successful in hiring a
senior officer upon terms acceptable to us. The holders of a majority of our
Series B Convertible Preferred Stock have the right to approve any action to
hire a new chief executive officer. If we select a new chief executive officer,
we cannot assure you that the holders of a majority of the Series B Convertible
Preferred Stock will approve the candidate we select. We expect our current
chief executive officer to continue to serve in a senior executive position
after the employment of the new executive, but we cannot assure you that he will
do so or effect an orderly transition to the new executive. Our failure to
retain the services of our current chief executive officer after the new
executive is employed could have a material adverse effect on our business. See
"Management -- Executive Officers and Directors" and "Description of
Securities -- Series B Convertible Preferred Stock."
OUR EQUIPMENT AND OPERATING SYSTEM, INCLUDING THE EQUIPMENT WE PLAN TO USE TO
PROVIDE DSL SERVICES, MAY NOT PERFORM AS WE EXPECT
We may never be able to deploy our DSL services as planned. An essential
element of our current strategy is provisioning switched local telephone service
and implementing DSL technology. In implementing our strategy, we may use new or
existing technologies in new applications. We also plan to use equipment
manufactured by multiple vendors. In addition, the DSL equipment we plan to use
has not previously been used to deliver the retail services we plan to offer. We
cannot assure you we will be able to successfully install and integrate the
technology and equipment necessary to deliver DSL services.
We employ a proprietary operations support system which is expected to be
an important factor in our success. If the operations support system fails or is
unable to perform as expected, it would have a substantial adverse effect on us.
Furthermore, problems may arise with higher processing volumes or with
additional automation features, which could potentially result in system
breakdowns and delays and additional, unanticipated expense to remedy the defect
or to replace the defective system with an alternative system.
OUR FAILURE TO MANAGE GROWTH COULD ADVERSELY AFFECT US
We may be unable to manage our growth effectively. This could have a
negative effect on our financial condition and our ability to fully implement
our expansion plans. The development and expansion of our business and our entry
into new markets will depend on, among other things, our
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ability to achieve the following goals in a timely manner, at reasonable costs
and on satisfactory terms and conditions:
- purchase, install and operate switches and other equipment, including DSL
equipment;
- accurately assess potential new markets;
- negotiate suitable interconnection and collocation arrangements with
incumbent local exchange carriers ("ILECs") on satisfactory terms and
conditions;
- hire and retain qualified personnel;
- lease suitable access to transport networks;
- lease or purchase suitable sites; and
- obtain required government authorizations.
We have experienced rapid growth since our inception, and we believe
sustained growth will place a strain on our operational, human and financial
resources. Our growth will also increase our operating complexity as well as the
level of responsibility for both existing and new management personnel. Our
ability to manage our expansion effectively will depend on the continued
development of plans, systems and controls for our operational, financial and
management needs and on our ability to expand, train and manage our employee
base.
OUR SERVICES MAY NOT ACHIEVE SUFFICIENT MARKET ACCEPTANCE TO BECOME PROFITABLE
Our success will depend upon the willingness of our target customers to
accept us as an alternative provider of local, long distance, high-speed data
and Internet services. The lack of acceptance by these customers would have a
negative impact on our business.
To date, we have offered only local and long distance communications
services. To address the needs of our target business customers, we are in the
process of developing additional products and services, such as high-speed data
and Internet services. However, we might not be able to provide the range of
communication services our target business customers need or desire.
The market for our proposed services has only recently begun to develop and
is highly competitive and evolving rapidly. We cannot assure you the market for
these services will develop or businesses will use high-speed data or
Internet-based services to the degree or in the manner we currently anticipate.
As a result, it is difficult for us to predict the extent to which our
high-speed data and Internet services will achieve market acceptance. To be
successful, we must develop and market services that are widely accepted by
businesses at profitable prices. If we are unable to react quickly to changes in
market conditions, if the market fails to develop or develops more slowly than
expected, or if our services do not achieve market acceptance, then our future
prospects will be reduced.
OUR FAILURE TO ACHIEVE OR SUSTAIN MARKET ACCEPTANCE AT DESIRED PRICING LEVELS
COULD IMPAIR OUR ABILITY TO ACHIEVE PROFITABILITY OR POSITIVE CASH FLOW
Prices for data communication services have fallen historically, a trend we
expect will continue. Accordingly, we cannot predict to what extent we may need
to reduce our prices to remain competitive or whether we will be able to sustain
future pricing levels as our competitors introduce competing services or similar
services at lower prices. Our ability to meet price competition may depend on
our ability to operate at costs equal to or lower than our competitors or
potential competitors. There is a risk competitors, perceiving us to lack
capital resources, may undercut our rates or increase their services in an
effort to force us out of business. Our failure to achieve or sustain market
acceptance at desired pricing levels could impair our ability to achieve
profitability or
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positive cash flow, which would have a material adverse effect on our business,
prospects, financial condition and operating results.
WE DEPEND ON INCUMBENT CARRIERS FOR COLLOCATION AND TRANSMISSION FACILITIES
We lease transport capacity from and rely upon our competitors. Because a
key element of our business and growth strategy is leasing transport capacity,
we are dependent upon the cooperation of ILECs and competitive local exchange
carriers ("CLECs") whose fiber optic networks and unbundled loops we lease. This
carries considerable risks, including the following:
- We must negotiate and renew favorable interconnection and collocation
agreements with other companies. The rates charged to us under the
interconnection agreements might not continue to be low enough for us to
attract a sufficient number of customers and to operate the business on a
profitable basis. In some cases, the rates that have been or will be
charged to us may be modified by regulatory proceedings, the result of
which we are unable to accurately predict.
- We rely on the timeliness of ILECs and CLECs which process our orders for
customers switching to our service and for the maintenance of unbundled
network elements to assure uninterrupted service. The ILECs have had
little experience in providing unbundled network elements to other
companies. Therefore, the ILECs might not be able to continue to provide
and maintain the unbundled network elements in a prompt and efficient
manner.
- Our interconnection agreements provide for our connection and maintenance
orders to receive attention on the same basis as the ILEC's or other
CLEC's customers and for the ILEC to provide adequate capacity to keep
blockage within industry standards. However, the ILECs might not continue
to comply with their network provisioning requirements. From time to
time, we have experienced excessive blockage in the delivery of calls
from the ILEC to our switches due to inadequate trunk provisioning by the
ILEC. Blocked calls result in customer dissatisfaction which may result
in the loss of business.
- We may not be able to lease adequate transport capacity in markets we
want to enter or renew our lease arrangements or obtain comparable
arrangements from other carriers in our existing markets. Because we
lease rather than build local transport capacity in each of our markets,
we would be unable to service our customers if we cannot obtain adequate
transport capacity.
WE DEPEND ON THIRD PARTIES FOR EQUIPMENT
We currently plan to purchase all of our equipment from a limited number of
vendors. If our suppliers enter into competition with us, or if our competitors
enter into exclusive or restrictive arrangements with our suppliers, it may
materially and adversely affect the availability and pricing of the equipment we
purchase.
The loss of any of our suppliers could have a material adverse effect on
our business, prospects, operating results and financial condition. We currently
rely and expect to continue to rely on a limited number of third party suppliers
to manufacture the equipment we require to implement our DSL technology. We
cannot assure you that our vendors will be able to meet our needs in a
satisfactory and timely manner in the future or that we will be able to obtain
alternative vendors when and if needed. Although we have identified alternative
suppliers and we are not constrained to use any exclusive supplier, it could
take a significant period of time to establish relationships with alternative
suppliers for critical technologies and to introduce substitute technologies
into our network. In addition, if we change vendors, we may need to replace all
or a portion of the DSL equipment deployed within our network. Our reliance on
third-party vendors involves a number of additional risks, including the absence
of guaranteed capacity and reduced control over delivery schedules, quality
assurance, production yields and costs.
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THE MARKET IN WHICH WE OPERATE IS HIGHLY COMPETITIVE AND WE MAY NOT BE ABLE TO
COMPETE EFFECTIVELY, ESPECIALLY AGAINST ESTABLISHED INDUSTRY COMPETITORS WITH
SIGNIFICANTLY GREATER FINANCIAL RESOURCES
When selling our local dialtone services, we compete with ILECs, which
currently dominate the local communications markets, and others. We also face
competition in most of our markets from one or more integrated communications
providers or CLECs. Through acquisitions, AT&T and MCI WorldCom have entered the
local dialtone market and other long distance carriers have announced their
intent to enter the local dialtone market. A continuing trend toward business
combinations and alliances in the communications industry may create significant
new competitors for us.
When offering long distance services, we compete with AT&T, MCI WorldCom,
Sprint and others. Our high-speed data and Internet services compete with
services offered by ILECs, long distance carriers, Internet service providers
and others. In particular, the market for Internet services is extremely
competitive and there are limited barriers to entry.
Many of these competitors are offering, or may soon offer, technologies and
services that will directly compete with some or all of our service offerings.
The competitive factors in our markets include reliability of service, breadth
of service availability, price performance, network security, transmission
speed, ease of access and use, content bundling, customer support, brand
recognition, operating experience, capital availability and exclusive contracts.
We believe we compare unfavorably with many of our competitors with regard to,
among other things, brand recognition, existing relationships with end users,
capital availability and exclusive contracts. Substantially all of our
competitors and potential competitors have substantially greater resources than
us. We may not be able to compete effectively in our target markets. Our failure
to compete effectively would have a material and adverse effect on our business,
prospects, operating results and financial condition.
For more information regarding the competitive environment in which we
operate, please see "Business -- Competition."
THE COMMUNICATIONS INDUSTRY IS UNDERGOING RAPID TECHNOLOGICAL CHANGE AND WE MAY
NOT BE ABLE TO OBTAIN OR IMPLEMENT NEW TECHNOLOGIES WHICH MAY BE NECESSARY TO
REMAIN COMPETITIVE
Rapid and significant changes in technology are expected in the
communications industry. While we believe for the foreseeable future these
changes will not materially affect or hinder our ability to acquire necessary
technologies, we cannot predict the effect of technological changes on our
business. Our future success will depend, in part, on our ability to anticipate
and adapt to technological changes, evolving industry standards and changing
needs of our current and prospective customers. We may be unable to obtain
access to new technology on acceptable terms or at all, and we may be unable to
adapt to new technologies and offer services in a competitive manner. Thus,
technological developments could negatively affect us.
A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS
Our success in marketing our services to business and residential users
requires us to provide reliable service. Our networks may be affected by
physical damage, power loss, capacity limitations, software defects, breaches of
security (by computer virus, break-ins or otherwise) and other factors which may
cause interruptions in service or reduced capacity for our customers.
Interruptions in service, capacity limitations or security breaches could have a
negative effect on customer acceptance and, therefore, on our business,
financial condition and results of operations.
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WE MAY BE UNABLE TO EFFECTIVELY DELIVER DSL SERVICES TO A SUBSTANTIAL NUMBER OF
CUSTOMERS
We cannot guarantee our network will be able to connect and manage a
substantial number of customers at high transmission speeds. We may be unable to
scale our network to serve a substantial number of customers while achieving
high performance. Further, our network may be unable to achieve and maintain
competitive digital transmission speeds. While digital transmission speeds of up
to 1.5 Mbps are possible on portions of our network, that speed may not be
available over a majority of our network. Actual transmission speeds on our
network will depend on a variety of factors many of which are beyond our
control, including the distance an end user is located from a central office,
the quality of the telephone lines, the presence of interfering transmissions on
nearby lines and other factors. As a result, we may not be able to achieve and
maintain digital transmission speeds that are attractive in the market.
OUR SERVICES MAY SUFFER BECAUSE THE TELEPHONE LINES WE REQUIRE MAY BE
UNAVAILABLE OR IN POOR CONDITION
Our ability to provide DSL services to potential customers depends on the
quality, physical condition, availability and maintenance of telephone lines
within the control of the ILECs. We believe the current condition of telephone
lines in many cases will be inadequate to permit us to fully implement our DSL
services. In addition, the ILECs may not maintain the telephone lines in a
condition that will allow us to implement our DSL services effectively. The
telephone lines may not be of sufficient quality or the ILECs may claim they are
not of sufficient quality to allow us to fully implement or operate our DSL
services. Further, some customers use technologies other than copper lines to
provide telephone services, and DSL might not be available to these customers.
INTERFERENCE OR CLAIMS OF INTERFERENCE COULD DELAY OUR ROLLOUT OR HARM OUR
SERVICES
Interference, or claims of interference by the ILECs, if widespread, could
adversely affect our speed of deployment, reputation, brand image, service
quality and customer satisfaction and retention. All transport technologies
deployed on copper telephone lines have the potential to interfere with, or to
be interfered with by, other transport technologies on the copper telephone
lines. We believe our DSL technologies, like other transport technologies, do
not interfere with existing voice services. We believe a workable plan that
takes into account all technologies could be implemented in a scalable way
across all ILECs using existing plant engineering principles. There are several
initiatives underway to establish national standards and principles for the
deployment of DSL technologies. We believe our technologies can be deployed
consistently with these evolving standards. Nevertheless, ILECs may claim the
potential for interference permits them to restrict or delay our deployment of
DSL services. Interference could degrade the performance of our services or make
us unable to provide service on selected lines. The procedures to resolve
interference issues between competitive carriers and ILECs are still being
developed, and these procedures may not be effective. We may be unable to
successfully negotiate interference resolution procedures with ILECs. Moreover,
ILECs may make claims regarding interference or unilaterally take action to
resolve interference issues to the detriment of our services. State or federal
regulators could also institute responsive actions.
OUR FUTURE SUCCESS WILL DEPEND ON GROWTH IN THE DEMAND FOR INTERNET ACCESS AND
HIGH-SPEED DATA SERVICES
If the markets for the services we offer, including Internet access and
high-speed data services, fail to develop, grow more slowly than anticipated or
become saturated with competitors, our business prospects, operating results and
financial condition could be materially adversely affected. The markets for
business Internet and high-speed data services are in the early stages of
development. Demand for Internet services is highly uncertain and depends on a
number of factors, including the growth in consumer and business use of new
interactive technologies, the development of technologies
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that facilitate interactive communication between organizations and targeted
audiences, security concerns and increases in data transport capacity.
In addition, the market for high-speed data transmission via DSL technology
is relatively new and evolving. Various providers of high-speed digital services
are testing products from various suppliers for various applications, and no
industry standard has been broadly adopted. Critical issues concerning
commercial use of DSL for Internet and high-speed data access, including
security, reliability, ease of use and cost and quality of service, remain
unresolved and may impact the growth of these services.
OUR INTERNET SERVICE MAY BE AFFECTED BY OUR ABILITY TO MAINTAIN PEERING
RELATIONSHIPS WITH OTHER INTERNET SERVICE PROVIDERS
The Internet is comprised of many Internet service providers and underlying
transport providers who operate their own networks and interconnect with other
Internet service providers at various points. As we commence the operation of
Internet services, transport will be provided via wholesale carriers. We
anticipate as our volume increases, we will enter into peering agreements for
the exchange of traffic with other Internet service providers.
We cannot assure you other national Internet service providers would
maintain peering relationships with us. Peering relationships with other
Internet service providers will permit us to exchange traffic with other
Internet service providers without incurring settlement charges. In addition,
the requirements associated with maintaining peering relationships with the
major national Internet service providers may change. We cannot assure you we
will be able to expand or adapt our network infrastructure to meet any new
requirements on a timely basis, at a reasonable cost, or at all.
WE MAY INCUR LIABILITIES AS A RESULT OF OUR INTERNET SERVICES
United States law relating to the liability of on-line service providers
and Internet service providers for information carried on, disseminated through,
or hosted on their systems is currently unsettled. If liability is imposed on
Internet service providers, we would likely implement measures to minimize our
liability exposure. These measures could require us to expend substantial
resources or discontinue some of our product or service offerings. In addition,
increased attention to liability issues, as a result of litigation, legislation
or legislative proposals could adversely affect the growth and use of Internet
services.
OUR SERVICES ARE HIGHLY REGULATED AND CHANGES IN CURRENT OR FUTURE LAWS OR
REGULATIONS COULD RESTRICT THE WAY WE OPERATE OUR BUSINESS
A significant number of the services we offer are regulated at the federal,
state and/or local levels. Future federal or state regulations and legislation
may be less favorable to us than current regulation and legislation and
therefore have an adverse impact on our business, prospects, operating results
and financial condition. In addition, we may expend significant financial and
managerial resources to participate in administrative proceedings at either the
federal or state level, without achieving a favorable result. The Federal
Communications Commission (the "FCC") makes rules applicable to interstate
communications, including rules implementing the Telecommunications Act, a
responsibility it shares with the state regulatory commissions. We believe ILECs
and others may work aggressively to modify or restrict the operation of many
provisions of the Telecommunications Act. We expect ILECs and others to continue
to pursue litigation in courts, institute administrative proceedings with the
FCC and other regulatory agencies and lobby the United States Congress, all in
an effort to affect laws and regulations in a manner favorable to them and
against the interest of CLECs such as us. If the ILECs or others succeed in any
of their efforts, if these laws and regulations change or if the administrative
implementation of laws develops in an adverse manner, it
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could have a material and adverse effect on our business, prospects and
operating results. For more details about our regulatory situation, please see
"Business -- Government Regulations."
THE PRICES WE CHARGE FOR OUR SERVICES AND PAY FOR THE USE OF SERVICES OF ILECS
AND OTHER CLECS MAY BE CHALLENGED IN REGULATORY PROCEEDINGS
If we were required to decrease the prices we charge for our services or to
pay higher prices for services we purchase from ILECs and other CLECs, it would
have an adverse effect on our business, prospects and operating results. We must
file tariffs with state and federal regulators which indicate the prices we
charge for our services. In addition, we purchase some tariffed services from
ILECs and/or CLECs. All of these tariffed prices may be challenged in regulatory
proceedings by customers, including ILECs, CLECs and long distance carriers who
purchase these services.
In addition, the rate we pay for other services we purchase from ILECs and
other CLECs are set by negotiations between the parties. These negotiated rates
are also subject to regulatory review. One of our interconnection agreements
requires a retroactive adjustment to the negotiated rate we pay for unbundled
loops when the state regulatory commission makes a final determination of the
appropriate rate. We believe the price we pay currently for unbundled loops
under this agreement will be reduced and therefore we have been recording our
cost for unbundled loops under this agreement based on management's best
estimate of the probable final rate. The difference between this rate and the
rate we currently pay for these services is recorded as an offset to accounts
payable. If the final rate is greater than our estimated rate, we would be
required to record additional costs for unbundled loops. In addition, if the
final rate is greater than the rate we currently pay for unbundled loops, we
will be required to pay the ILEC the incremental difference for the unbundled
loops we have ordered since inception. If we were required to retroactively
increase the amount we have recorded as our cost for unbundled loops under this
interconnection agreement or increase the additional costs we expect to
recognize in the future, it could have a material adverse effect on our
operating results.
THE ACCESS CHARGES WE COLLECT FROM LONG DISTANCE CARRIERS MAY BE REDUCED AS A
RESULT OF REGULATORY CHALLENGES
We may not be able to collect all of the access charges we have billed to
long distance carriers. When our facilities are used to originate a customer's
long distance call and deliver it to the long distance carrier designated by the
customer, or to terminate a long distance call received from a long distance
carrier by delivering it to a telephone number connected to our network, the
long distance carrier is required to pay us for access to our network and the
use of our facilities. These charges are called "access charges." Access charges
represented 41% of our operating revenues in 1998 and 36% of our operating
revenues in first quarter 1999. AT&T, Sprint and MCI WorldCom have recently
refused to pay the full amount of access charges billed to them under our
tariffs. Access charge revenues from AT&T, Sprint and MCI WorldCom represented
81% of our total access charge revenues in 1998 and 72% of our total access
charge revenues in the first quarter 1999. As of March 31, 1999, we reflected
approximately $5.6 million of access charges as accounts receivable, which
amount is reflected net of a discount we established in the event some of these
access charges are not paid by AT&T, Sprint or MCI WorldCom. We cannot assure
you the discount we have established is adequate. We have initiated proceedings
against AT&T at the FCC under an FCC procedure for expedited settlement of
disputes between common carriers. We are currently negotiating with Sprint and
MCI WorldCom and have submitted our dispute with MCI WorldCom to arbitration.
The law applicable to our disputes with AT&T, Sprint and MCI WorldCom is unclear
and we may not be able to collect the full amount of the access charges owed to
us by these long distance carriers. See "Business -- Legal Proceedings."
We anticipate access charges billed to long distance carriers will continue
to represent a substantial portion of our operating revenues and that the access
charges billed to AT&T, Sprint and
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MCI WorldCom will continue to represent a substantial portion of the total
amount of access charges we bill to long distance carriers.
WE WILL FACE ADDITIONAL RISKS IF WE ACQUIRE OTHER BUSINESSES
We may acquire other businesses as a means of expanding into new markets or
developing new services. We are unable to predict whether or when any
prospective acquisitions will occur or the likelihood of any acquisition being
completed on favorable terms and conditions. Acquisitions of other businesses
involve risks including:
- difficulties assimilating acquired operations and personnel;
- potential disruptions of our ongoing business;
- the diversion of resources and management time;
- the possibility uniform standards, controls, procedures and policies may
not be maintained;
- risks associated with entering new markets in which we have little or no
experience; and
- the potential impairment of relationships with employees or customers as
a result of changes in management.
Any business we might acquire might not perform as expected.
FUTURE SALES OF OUR STOCK BY EXISTING STOCKHOLDERS MAY ADVERSELY AFFECT OUR
STOCK PRICE
Substantially all of our common stock is currently eligible for sale in the
open market. In addition, shares of our common stock issued upon exercise of
stock options are freely tradeable under a currently effective registration
statement. Sales and potential sales of substantial amounts of our common stock
in the open market could cause the market price for our common stock to fall.
See "Description of Securities -- Shares Eligible for Future Sale."
The holders of some of our outstanding shares of common stock and
convertible securities have demand registration rights which if exercised could
result in a registration statement covering shares of common stock being filed
by us. These holders also have the right to have shares of common stock included
in any registration statement filed by us in the future. See "Description of
Securities -- Registration Rights of Security Holders."
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could fluctuate widely in response to a variety of
factors, including:
- actual or anticipated variations in quarterly operating results;
- announcements of technological innovations;
- new products or services offered by us or our competitors;
- changes in financial estimates by securities analysts;
- significant acquisitions, strategic partnerships, joint ventures or
capital commitments;
- additions or departures of key personnel;
- sales of common stock; and
- other events or factors that may be beyond our control.
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In addition, the Nasdaq National Market, where many publicly held
communications companies like us are traded, has recently experienced extreme
price and volume fluctuations. These fluctuations often have been unrelated or
disproportionate to the operating performance of these companies. Broad market
and industry factors may materially adversely affect the market price of our
common stock, regardless of our actual operating performance.
WE DO NOT INTEND TO PAY CASH DIVIDENDS
We have never declared or paid any cash dividends on our common stock and
do not expect to declare any dividends in the foreseeable future. Payment of any
future dividends will depend upon our earnings and capital requirements, our
debt facilities and other factors our Board of Directors considers appropriate.
We intend to retain our earnings, if any, to finance the development and
expansion of our business, and therefore we do not anticipate paying any cash
dividends in the foreseeable future. Our ability to declare and pay cash
dividends on our common stock is restricted by covenants in our debt indenture
and the terms of our outstanding preferred stock.
INVESTORS IN THIS OFFERING WILL PAY MORE PER SHARE THAN THE BOOK VALUE
There will be an immediate and substantial dilution of your investment in
our common stock, in that the net tangible book value per share of stock after
this offering will be substantially less than the per share offering price of
the common stock. See "Dilution."
OUR FAILURE AND THE FAILURE OF THIRD PARTIES TO BE YEAR 2000 COMPLIANT COULD
NEGATIVELY IMPACT OUR BUSINESS
For a discussion of risks presented by our ability and the ability of
others on whom we rely to successfully make computer systems and other
technology Year 2000 compliant, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Impact of Year 2000" in this
prospectus.
MANAGEMENT OWNS A SIGNIFICANT PERCENTAGE OF OUR COMPANY AND WILL BE ABLE TO
EXERCISE SIGNIFICANT INFLUENCE OVER OUR ACTIONS
We are controlled by our officers and directors, who in the aggregate own
43.8% of our outstanding common stock and voting power. Accordingly, these
stockholders collectively will likely be able to continue to control our
management policy, decide all fundamental corporate actions, including mergers,
substantial acquisitions and dispositions and elect our Board of Directors.
MANAGEMENT HAS BROAD DISCRETION TO USE THE PROCEEDS FROM THIS OFFERING
Our management will have broad discretion over the use of the proceeds
raised in this offering, and you must rely on the judgment of management in the
application of the proceeds. Please see "How We Intend to Use the Proceeds of
this Offering" for more information related to our financing plan.
WE MUST OBTAIN REGULATORY APPROVAL BEFORE THIS OFFERING MAY BE COMPLETED
Prior to issuing any equity, we must obtain the approval of the State of
Georgia. Because of time constraints, we will not have obtained approval from
the State of Georgia before closing this offering. After consultation with
counsel, we believe the approval will be granted and that seeking approval after
this offering should not result in any material adverse consequences to us,
although we cannot assure you of a favorable result.
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OUR FORWARD-LOOKING STATEMENTS MAY MATERIALLY DIFFER FROM ACTUAL EVENTS OR
RESULTS
This prospectus contains "forward-looking statements," which you can
generally identify by our use of forward-looking words such as "believe,"
"expect," "intend," "may," "will," "should," "could," "anticipate" or "plan" or
the negative or other variations of these terms or comparable terminology, or by
discussion of strategies that involve risks and uncertainties. We often use
these types of statements when discussing our plans and strategies, our
anticipation of profitability or cash flow from operations, and statements
regarding the development of our business, the market for our services and
products, our anticipated capital expenditures, operations support systems,
changes in regulatory requirements and other statements contained in this
prospectus regarding matters that are not historical facts.
We caution you these forward-looking statements are only predictions and
estimates regarding future events and circumstances. We cannot assure you we
will achieve the future results reflected in these statements. The risks we face
that could cause us not to achieve these results include, but are not limited to
those described above.
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HOW WE INTEND TO USE THE PROCEEDS OF THIS OFFERING
The net proceeds we receive from the sale of the 5,000,000 shares of common
stock we are offering are estimated to be approximately $122.9 million based on
an assumed offering price of $26.00 per share and after deducting estimated
underwriting discounts and other offering expenses payable by us. We will
receive approximately $143.6 million if the over-allotment option granted to the
underwriters is exercised in full. We will not receive any proceeds from the
sale of any shares sold by the selling stockholders. We intend to use the net
proceeds for capital expenditures related to the purchase and installation of
DSL and other communications equipment and for general corporate purposes,
including working capital to fund our expanded sales and marketing efforts. In
addition, we may use a portion of the net proceeds for acquisitions, although we
are not involved in any acquisition negotiations at this time. See "Risk
Factors -- We will face additional risks if we acquire other businesses" and
"-- Management has broad discretion to use the proceeds from this offering."
Pending use of the net proceeds as described above, we intend to invest
them in short-term, investment grade securities.
DIVIDEND POLICY
We have never paid cash dividends on our capital stock and we do not
anticipate paying cash dividends in the foreseeable future. Any future
determination to pay cash dividends will be at the discretion of our Board of
Directors and will be dependent upon our financial condition, results of
operations, capital requirements and other factors our Board of Directors
considers relevant. In addition, the terms of our outstanding indebtedness and
preferred stock restrict our ability to pay cash dividends on our common stock.
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CAPITALIZATION
The following table shows our capitalization as of March 31, 1999, on (A)
an actual basis, (B) on an adjusted basis to reflect the sale of 5,277,779
shares of Series B Convertible Preferred Stock, and (C) on an adjusted basis to
reflect the sale of 5,277,779 shares of Series B Convertible Preferred Stock and
the 5,000,000 shares of common stock we are offering at an assumed public
offering price of $26.00 per share, after deducting estimated underwriting
discounts and offering expenses.
You should read this table with our financial statements and the related
notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1999
--------------------------------------------
ACTUAL AS ADJUSTED(1) AS ADJUSTED(2)
-------- -------------- --------------
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C>
Cash and cash equivalents and investments
available-for-sale (excluding restricted
investments)................................. $ 55,307 $101,807 $224,657
Restricted investments......................... 39,929 39,929 39,929
-------- -------- --------
Total cash and cash equivalents, investments
available-for-sale and restricted
investments............................... 95,236 141,736 264,586
13% Senior Secured Notes due 2004.............. 156,837 156,837 156,837
Other long-term debt........................... 449 449 449
Series B Convertible Preferred Stock........... -- 46,500 46,500
Stockholders' equity
Common stock -- par value.................... 17 17 22
Common stock -- paid in capital in excess of
par value................................. 109,231 109,231 232,076
Accumulated deficit.......................... (58,604) (58,604) (58,604)
Accumulated other comprehensive income....... 178 178 178
Notes receivable from stockholders for
issuance of common stock.................. (2,173) (2,173) (2,173)
-------- -------- --------
Total stockholders' equity................... 48,649 48,649 171,499
-------- -------- --------
Total capitalization........................... $205,935 $252,435 $375,285
======== ======== ========
</TABLE>
- -------------------------
(1) Gives effect to the issuance of 5,277,779 shares of Series B Convertible
Preferred Stock.
(2) Gives effect to the issuance of 5,277,779 shares of Series B Convertible
Preferred Stock and this offering based on an assumed offering price of
$26.00 per share.
22
<PAGE> 23
DILUTION
The net tangible book value of a share of our common stock is the
difference between our tangible assets and our liabilities, divided by the
number of shares of common stock outstanding. For investors in the common stock,
dilution is the difference between the assumed $26.00 per share offering price
of the common stock and the net tangible book value per share of common stock
immediately after completing this offering. Dilution in this case results from
the fact that the per share offering price of the common stock is substantially
higher than the per share price paid by our existing stockholders for our
presently outstanding stock.
On March 31, 1999, our net tangible book value was approximately $90.4
million after giving effect to the sale of 5,277,779 shares of Series B
Convertible Preferred Stock in May 1999, and the per share net tangible book
value of each of the assumed outstanding shares of common stock (assuming the
Series B Convertible Preferred Stock had been converted into 5,277,779 shares of
common stock) was approximately $4.01 per share.
As of March 31, 1999, without taking into account any changes in our net
tangible book value after that date other than to give effect to the sale of the
Series B Convertible Preferred Stock and the sale of the common stock offered in
this offering, based on an assumed offering price of $26.00 per share, the
estimated offering expenses, including the underwriting discount, the net
tangible book value of each of the assumed outstanding shares of common stock
would have been $7.75 per share. Therefore, you would have paid $26.00 for a
share of common stock having a net tangible book value of approximately $7.75
per share; that is, your investment would have been diluted by approximately
$18.25 per share. At the same time, existing stockholders would have realized an
increase in net tangible book value of $3.74 per share without further cost or
risk to themselves. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Price per share of common stock in this offering..... $26.00
Net tangible book value per share of common stock
before this offering(1)......................... $4.01
Increase in net tangible book value per share of
common stock attributable to investors in this
offering(2)(3).................................. 3.74
-----
Net tangible book value per share of common stock
after this offering(2)(3)....................... 7.75
------
Dilution to new investors(3)......................... $18.25
</TABLE>
- -------------------------
(1) After giving effect to the sale of 5,277,779 shares of Series B Convertible
Preferred Stock in May 1999.
(2) After deducting the estimated offering expenses payable by us, including the
underwriting discount.
(3) Assumes that none of our outstanding options or warrants are exercised and
assumes the conversion of 5,277,779 shares of Series B Convertible Preferred
Stock which are convertible into shares of common stock on a one-for-one
basis.
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<PAGE> 24
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
You should read the following selected consolidated financial and operating
data with our consolidated financial statements and the related notes and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," each of which can be found elsewhere in this prospectus. The
selected consolidated statements of operations data presented below for the
years ended December 31, 1996, 1997 and 1998 are derived from our consolidated
financial statements, which have been audited by KPMG LLP (1996) and Arthur
Andersen LLP (1997 and 1998), independent auditors.
<TABLE>
<CAPTION>
QUARTER ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------ -------------------
1996 1997 1998 1998 1999
------- ------- -------- ------- --------
(AUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues..................... $ 1 $ 3,791 $ 18,249 $ 2,846 $ 8,401
Cost of operating revenues............. 305 3,928 17,129 2,371 8,483
Selling, general and administrative
expenses............................. 841 6,440 17,877 2,562 7,727
Loss from operations................... (1,554) (7,851) (21,995) (2,954) (11,293)
OTHER FINANCIAL DATA:
EBITDA(1).............................. $(1,145) $(6,577) $(16,757) $(2,087) $ (7,809)
Capital expenditures................... 3,659 22,641 97,101 10,671 15,240
OPERATING DATA (END OF PERIOD):
Total access lines in service.......... 50 15,590 47,744 20,924 65,147
Central office collocation sites....... 9 25 207 29 233
Switches in service.................... 1 3 7 3 7
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
-------------------------
ACTUAL AS ADJUSTED(2)
-------- --------------
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents and investments available-for-sale
(excluding restricted investments)........................ $ 55,307 $224,657
Restricted investments...................................... 39,929 39,929
Property and equipment, net................................. 128,136 128,136
Total assets................................................ 237,553 407,068
Long-term debt.............................................. 157,286 157,286
Series B Convertible Preferred Stock........................ -- 46,500
Stockholders' equity........................................ 48,649 171,499
</TABLE>
- -------------------------
(1) EBITDA consists of earnings before interest, income taxes, depreciation and
amortization. For the year ended December 31, 1996, EBITDA excludes a charge
of $355,000 related to the one-time write-off of purchased software. EBITDA
does not represent funds available for management's discretionary use and is
not intended to represent cash flow from operations. EBITDA should not be
considered as an alternative to loss from operations as an indicator of our
operating performance or to cash flows as a measure of liquidity. In
addition, EBITDA is not a term defined by generally accepted accounting
principles and, as a result, the measure of EBITDA may not be comparable to
similarly titled measures used by other companies. We believe that EBITDA is
often reported and widely used by analysts, investors and other interested
parties in the communications industry. Accordingly, we are including this
information to permit a more complete comparison of our operating
performance relative to other companies in the industry.
(2) Gives effect to the issuance of 5,277,779 shares of Series B Convertible
Preferred Stock in May 1999 and to this offering based on an assumed
offering price of $26.00 per share.
24
<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with our financial
statements and the notes related to our financial statements, each of which can
be found elsewhere in this prospectus. The results shown in this prospectus do
not necessarily indicate the results to be expected in any future periods. This
discussion contains forward-looking statements. We caution you these
forward-looking statements are only predictions and estimates regarding future
events and circumstances. We cannot assure you we will achieve the future
results reflected in these statements. Our actual results may differ from those
anticipated due to a number of factors, including those described in the section
entitled "Risk Factors" and elsewhere in this prospectus.
OVERVIEW
We began providing competitive local dialtone services to small business
and residential customers in December 1996 and began offering long distance
services by February 1998. Currently, we have switches fully operational in Las
Vegas, Atlanta, Chicago, southern Florida, and in selected areas of southern
California, including Los Angeles and San Diego.
Our 1997 revenues were generated from sales of communications services
consisting primarily of local phone service, switched access billings and
non-recurring charges, principally installation charges. In 1998 and first
quarter 1999, long distance services also contributed to our revenue base.
Our 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 collocation lease expenses. Selling,
general and administrative expenses consist primarily of compensation expenses,
advertising, provision for bad debts, professional fees and office rentals.
Depreciation and amortization expense includes depreciation of switching and
collocation equipment as well as general property and equipment.
During 1998, we expanded significantly with the installation of four
additional switches and the build-out of 182 additional collocation sites. As
expected, both cost of operating revenues and selling, general and
administrative costs increased 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, we incurred significant marketing costs to build our
initial base of customers in our new markets.
Building and expanding our business has required and will continue to
require us to incur significant capital expenditures primarily consisting of the
costs of purchasing switches, associated equipment and land for switching sites
and constructing buildings or improving leased buildings to house our switching
and collocation facilities. As part of our "smart build" network strategy, we
purchased and installed host switches in each of our markets while leasing the
means of transporting voice and data traffic from these switches to our
customers' telephones or other equipment. We believe this facilities-based
strategy, while initially increasing our level of capital expenditures and
operating losses, will enhance our long-term financial performance in comparison
to a resale strategy.
We have experienced operating losses and generated negative cash flow from
operations since inception and expect to continue to generate negative cash flow
from operations for the foreseeable future while we continue to expand our
network and develop our product offerings and customer base. There can be no
assurance our revenue or customer base will grow or that we will be able to
achieve or sustain positive cash flow from operations. See "Risk Factors -- We
expect our losses to continue."
25
<PAGE> 26
RESULTS OF OPERATIONS
QUARTER ENDED MARCH 31, 1999 VS. 1998
Total operating revenues increased to $8.4 million for the quarter ended
March 31, 1999 as compared to $2.8 million for the quarter ended March 31, 1998.
The 195% increase is a result of the increase in the number of lines in service
and increased long distance service revenue. We had 65,147 lines in service at
the end of the first quarter 1999 as compared to 20,924 lines in service at
March 31, 1998, a 211% increase.
Cost of operating revenues for the quarter ended March 31, 1999 was $8.5
million as compared to $2.4 million for the quarter ended March 31, 1998. The
258% increase is due to the increased number of lines in service and
installation and operational expenses associated with the expansion of our
network.
For the quarter ended March 31, 1999, selling, general and administration
expenses totaled $7.7 million, a 202% increase over the $2.6 million for the
quarter ended March 31, 1998. The increase is a result of increased costs
attributable to marketing and delivering our service and supporting our
continued network expansion.
For the quarter ended March 31, 1999, depreciation and amortization was
$3.5 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 to support the
planned build-out of our network.
Gross interest expense for each of the quarters ended March 31, 1999 and
March 31, 1998 totaled $5.6 million. Interest capitalized for the quarter ended
March 31, 1999 increased to $1.0 million as compared to $0.1 million for the
quarter ended March 31, 1998. This increase is due to the increase in switching
equipment under construction. Gross interest expense is primarily attributable
to the 13% Senior Secured Notes due 2004 (the "Senior Secured Notes") we issued
in September 1997.
Interest income was $1.5 million during the quarter ended March 31, 1999
compared to $2.2 million for the quarter ended March 31, 1998. The 31% decrease
is a result of the decrease in cash and investments since March 31, 1998. Cash
and investments have been used to purchase switching equipment, pay interest on
our Senior Secured Notes and fund operating losses.
We incurred net losses of $14.2 million during the first quarter 1999 and
$6.3 million during the first quarter 1998.
YEAR ENDED DECEMBER 31, 1998 VS. 1997
Total operating revenues for the year ended December 31, 1998 were $18.2
million as compared to $3.8 million for the year ended December 31, 1997. The
381% increase is a result of the installation of four additional switches, an
increase in the number of lines in service and the introduction of long distance
service in early 1998. We provided communications services in only Las Vegas
until December, 1997 when we initiated service in Atlanta and southern
California. As a result of our network expansion, during 1998 we began to offer
service in Chicago and additional areas of southern California, including Los
Angeles and San Diego. We had 47,744 lines in service as of December 31, 1998 as
compared to 15,590 lines in service as of December 31, 1997, a 206% increase.
Cost of operating revenues for the year ended December 31, 1998 was $17.1
million as compared to $3.9 million for the year ended December 31, 1997. The
336% increase is due to the increased number of lines in service during 1998,
network expenses associated with long distance service, and installation and
operational expenses associated with the significant expansion of our network.
For the year ended December 31, 1998, selling, general and administrative
expenses totaled $17.9 million, a 178% increase over the $6.4 million for the
year ended December 31, 1997. The
26
<PAGE> 27
increase in expenses resulted from increased costs attributable to marketing of
services, delivering our service and supporting our continued network expansion.
For the year ended December 31, 1998, depreciation and amortization was
$5.2 million as compared to $1.3 million for the year ended December 31, 1997.
This increase is a result of placing additional assets in service during the
period to support our planned build-out of our network. As of December 31, 1998
we had seven operational switches and 207 collocation sites built out as
compared to three switches and 25 collocations sites as of December 31, 1997.
Interest expense for fiscal 1998 totaled $19.1 million as compared to $5.5
million for fiscal 1997. The increase is primarily attributable to a full year
of interest incurred on the Senior Secured Notes we issued in September 1997.
Interest income was $8.8 million for the year ended December 31, 1998
compared to $2.5 million for the year ended December 31, 1997. The income is
attributable to earnings on investments made with the proceeds from the issuance
of the Senior Secured Notes and with the proceeds from the sale of our common
and preferred stock.
We incurred net losses of $32.1 million during 1998 and $10.8 million
during 1997.
YEAR ENDED DECEMBER 31, 1996
Our operations before December 1996 were limited to start-up activities
and, as a result, our revenues and expenditures for the period were not
indicative of anticipated revenues which may be attained or expenditures which
may be incurred by us in future periods. We did not begin revenue-generating
operations until December 1996. As a result, any comparison of the year ended
December 31, 1997 with the year ended December 31, 1996 would not be meaningful.
During the year ended December 31, 1996, we generated $1,000 in operating
revenues as a result of commencing service during the month of December. We had
cost of operating revenues of $0.3 million which represents primarily fixed
costs. In addition, we incurred other operating expenses, including depreciation
and amortization, of $1.3 million in connection with the commencement of
operations and the build-out of our network. These expenses consisted primarily
of payroll expenses, professional fees, expenses related to the introduction of
initial service and a one-time write-off of purchased software.
We earned interest income in the period of $0.1 million.
As a result, we incurred a net loss in the period of $1.5 million. This
loss is primarily attributable to the expenses incurred in connection with the
initial development of our business.
LIQUIDITY AND CAPITAL RESOURCES
Our operations require substantial capital investment for the purchase of
communications equipment and the development and installation of our network.
Capital expenditures were $15.2 million for the quarter ended March 31, 1999,
$97.1 million for the year ended December 31, 1998 and $22.6 million for the
year ended December 31, 1997. We expect we will continue to require substantial
amounts of capital to fund the purchase of the equipment necessary to continue
expanding our network footprint in our existing markets and to develop new
products and services. In addition, we expect to enter new markets during 2000.
We expect capital expenditures of approximately $400 million over the next five
years, including $45.1 million of capital expenditures expected during the last
six months of 1999, which will be funded from cash on hand and public or private
debt or equity financing. In addition, we are currently evaluating financing
proposals from vendor and equipment lease financing companies. We cannot assure
you that we will be successful in raising sufficient debt or equity capital on
acceptable terms.
From our inception through September 1997, we raised approximately $17.8
million from private sales of common stock.
27
<PAGE> 28
In September 1997, we completed a $160.0 million offering of Senior Secured
Notes and warrants to purchase 862,923 shares of common stock (after giving
effect to anti-dilution adjustments). At the closing of the sale of the Senior
Secured Notes, we 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. In addition, we have granted the holders of the Senior Secured
Notes a security interest in a substantial portion of our communications
equipment.
In November 1997 and January 1998, we 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.
We completed our initial public offering of common stock on May 15, 1998.
We sold a total of 4,025,000 shares of our common stock to the public and
received net proceeds of $63.0 million. In connection with the initial public
offering of our common stock, we reduced the number of authorized and
outstanding shares of our common stock by 40%. Our outstanding shares of
preferred stock were converted into 3,942,856 shares of common stock upon our
initial public offering.
In May 1999, we issued 5,277,779 shares of Series B Convertible Preferred
Stock at $9.00 per share for net proceeds of approximately $46.5 million.
In addition, we are currently negotiating a vendor facility to finance at
least $20 million of DSL equipment. We cannot assure you that we will be able to
obtain this vendor financing in a timely manner, on terms we consider acceptable
or at all.
The substantial capital investment required to initiate services and fund
our initial operations has exceeded our operating cash flow. This negative cash
flow from operations results from the need to establish our network in
anticipation of connecting revenue-generating customers. We expect to continue
recording negative cash flow from operations for a period of time because we are
continuing network expansion activities. We cannot assure you we will attain
break-even cash flow from operations in subsequent periods. Until sufficient
cash flow from operations is generated, we will need to use our current and
future capital resources to meet our cash flow requirements and may be required
to issue additional debt and/or equity securities. We expect our available cash
and the proceeds of this offering should be adequate to fund our operations and
planned capital expenditures through the end of the third quarter 2000. The
indenture governing the Senior Secured Notes and the terms of our Series B
Convertible Preferred Stock impose restrictions upon our ability to incur
additional debt or issue preferred stock.
IMPACT OF YEAR 2000
The year 2000 issue, commonly referred to as Y2K, is a result of the way
some computer systems store dates. In many cases, when a date is stored by a
computer, a two digit field has been used to store the year (i.e., 01/01/98 =
January 1, 1998). The system assumes that the first two digits in the year field
are "19." With the end of the century approaching, those same systems should
reflect 01/01/00 as being "January 1, 2000." However, a non-compliant system
will read 01/01/00 as January 1, 1900.
We have been focused on year 2000 issues since our inception in 1996. In
recognition of the priority associated with the year 2000 issue, we have
established a Year 2000 Project Team at the corporate level to lead the year
2000 effort. Since we are young, much of the hardware and software currently in
place was purchased with Y2K readiness in mind. However, in most cases, we have
relied on representations of our vendors as to the Y2K compliance of the
hardware and software we have purchased. We cannot assure you the vendor
representations we relied upon are accurate or complete or that we will have
recourse against any vendors whose representations prove misleading.
28
<PAGE> 29
Our Y2K plans include a number of phases designed to evaluate the Y2K
readiness of our network and computer systems. We have completed the inventory
and assessment of all network and information systems and have begun the
renovation and testing phases. Renovations of mission critical components of our
network and operations support system for Year 2000 compliance were completed in
June 1999. We will continue integration testing throughout the remainder of
1999. Subject to additional compliance testing, we believe our essential
processes, systems and business functions will be ready for the 1999 to 2000
transition.
Our significant vendors, including our major communications equipment
suppliers, have assured us their applications are year 2000 compliant. Our
business also relies on other third parties. The ability of third parties upon
whom we rely to adequately address their year 2000 issues is outside our
control. However, we are coordinating efforts with these parties to minimize the
extent to which our business will be vulnerable to their failure to remediate
their own year 2000 issues. We cannot assure you the systems of the third
parties will be modified on a timely basis. Our business, financial condition
and results of operations could be materially adversely affected by the failure
of the systems and applications of third parties to properly operate after 1999.
We are in the process of developing contingency plans should mission
critical systems fail as a result of Y2K issues.
In a recent SEC release regarding year 2000 disclosure, the SEC stated that
public companies must disclose the most reasonably likely worst case year 2000
scenario. Although it is not possible to assess the likelihood of any of the
following events, each must be included in a consideration of worst case
scenarios: widespread failure of electrical, gas and similar suppliers serving
us; widespread disruption of the services provided by common carriers; similar
disruption to the means and modes of transportation for our employees,
contractors, suppliers and customers; significant disruption to our ability to
gain access to, and remain working in, office buildings and other facilities;
the failure of substantial numbers of our critical computer hardware and
software systems, including both internal business systems and systems
controlling operational facilities such as electrical generation, transmission
and distribution systems; and the failure of outside entities' systems,
including systems related to banking and finance.
If we cannot operate effectively after December 31, 1999, we could, among
other things, face substantial claims by customers or loss of revenue due to
service interruptions, inability to fulfill contractual obligations or to bill
customers accurately and on a timely basis, as well as increased expenses
associated with litigation, stabilization of operations following critical
system failures and the execution of contingency plans. We could also experience
an inability by customers and others to pay, on a timely basis or at all,
obligations owed to us. Under these circumstances, the adverse effects, although
not quantifiable at this time, could be material.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
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. We currently expense all start-up costs as incurred and
consequently, the application of SOP 98-5 will have no material impact on our
financial statements.
29
<PAGE> 30
BUSINESS
MGC COMMUNICATIONS
We are a growing communications company currently offering local dialtone,
long distance and other voice services to small business and residential
customers. We expect to offer bundled voice and high-speed data services using
DSL technology in some of our markets later this year. We have one of the
largest collocation footprints, with 233 central office collocation sites
providing us access to approximately 12.8 million addressable lines, including
an estimated 4.0 million small business lines. We currently deliver our services
in the metropolitan areas of Atlanta, Chicago, Las Vegas, southern Florida and
selected areas of southern California, including Los Angeles and San Diego. We
have interconnection agreements with five ILECs: Ameritech, BellSouth, GTE,
PacBell and Sprint. At the end of the first quarter of 1999, we had 79,332
customer lines sold, of which 65,147 lines were in service. During 1999, we plan
to continue expanding our network to over 300 central office collocation sites
providing access to approximately 17 million addressable lines.
We were one of the first CLECs to implement a "smart-build" strategy,
building and owning the intelligent components of our network -- switches and
collocation facilities -- while leasing unbundled loops and transport from other
common carriers. For an explanation of certain terms used in this prospectus to
describe our network and its components, please read the section entitled
"-- Network Architecture and Technology." We believe this "smart-build" strategy
has allowed us to quickly establish a large collocation footprint at a
comparatively low cost while maintaining control of access to our customers.
Having executed our "smart-build" strategy, we are well-positioned to serve the
growing demand from small business customers for communications services.
The rapid growth of the Internet has fueled demand from small businesses
for access to high-speed data services. To meet this growing demand, we expect
to use our current network infrastructure to offer a bundled voice and
high-speed data product over a single copper unbundled loop by implementing DSL
as a data transport solution. On average, DSL technology increases the transport
capacity of standard copper telephone lines by 24 times. This increased capacity
will allow us to meet the growing demand for high-speed data services and to
deliver multiple voice telephone lines to a customer using a single unbundled
loop which we lease from the ILEC. By using a single unbundled loop to deliver a
bundled voice and high-speed data product, we expect to significantly reduce the
per line costs of provisioning customer lines and the associated leased
transport and unbundled loop costs. These savings should allow us to offer a
value-priced package of services to our customers. Several of our customers are
testing our bundled voice and high-speed data product, which is delivered via
DSL. We plan to offer this product to small businesses in select markets later
this year.
MARKET OPPORTUNITY
We believe we have a significant market opportunity as a result of the
following factors:
Impact of the Telecommunications Act of 1996
The Telecommunications Act of 1996 allows CLECs to use the existing
infrastructure established by ILECs, as opposed to building a competing
infrastructure at significant cost. The Telecommunications Act requires all
ILECs to allow CLECs to collocate their equipment in the ILEC's central offices.
This enables CLECs to access customers through existing telephone line
connections. The Telecommunications Act creates an incentive for ILECs that were
formerly part of the Bell system to cooperate with CLECs by precluding these
ILECs from providing long distance service in their region until regulators
determine there is a significant level of competition in the ILEC's local
market. See "-- Government Regulations."
30
<PAGE> 31
Needs of Small Businesses for Integrated Communications Solutions
Many small businesses have no cost-effective alternative to dial-up modems
for Internet access. As a result, these businesses must contend with
productivity limitations associated with slow transmission speeds. In addition,
to meet their communications needs, small businesses are subject to the cost and
complexity of utilizing multiple service providers: local dialtone providers,
long distance carriers, Internet service providers and equipment integrators. We
believe these businesses can benefit significantly from an integrated
cost-effective communications solution delivered by a single service provider.
Growing Market Demand for High-Speed Data Services
The popularity of the Internet with consumers and the development of the
Internet as a commercial medium have driven the demand for high-speed data
services. Businesses are increasingly establishing Web sites and corporate
intranets and extranets to expand their customer reach and improve their
communications efficiency. To remain competitive, small businesses increasingly
need high-speed data and Internet connections to access critical business
information and communicate more effectively with employees, customers, vendors
and business partners. High-speed digital connections are also becoming
increasingly important to businesses and consumers as more information and
applications become available on the Internet.
Emergence of DSL Technology
DSL technology emerged in 1990 and is now commercially available. DSL
technology dramatically increases the data, voice and video carrying capacity of
standard copper telephone lines. Because DSL technology uses existing copper
telephone lines, a broad network deployment can be implemented rapidly and
requires a lower initial fixed investment than some existing alternative
technologies. In addition, since a significant portion of the expense associated
with a DSL network is incurred only when a new customer is added to the network,
capital is efficiently deployed.
THE MGC SOLUTION
We believe we offer an attractive communications solution to small business
and residential customers. In developing our solution, we have attempted to
include elements intended to create customer loyalty. Key aspects of our
solution include:
Simple, Competitive Flat Rate Packages. We offer our customers simple,
value-priced solutions for their communications requirements, all on a single
bill. Today we offer high quality basic communications products and services,
including local dialtone, custom calling features, long distance and dial-up
Internet access, at discounted prices. Our flat rate, bundled packages eliminate
the need for our customers to choose among a broad array of communications
options.
"One-Stop" Communications Solutions. Through the implementation of DSL
technology, we expect to offer a "one-stop" communications solution for our
customers, which will include our current communications products bundled with
high-speed data access. Our customers will have a single point of contact for a
complete package of services, eliminating the need for our customers to manage
multiple vendors.
Service Reliability. We are able to offer our customers a high degree of
service reliability through efficient, timely execution of provisioning
unbundled loops due to our mature relationships with five ILECs. We believe the
introduction of DSL technology will enable us to further improve our service
reliability by simplifying the provisioning process. Moreover, our customer
service center is staffed to respond promptly to customer inquiries 24 hours a
day, seven days a week.
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<PAGE> 32
BUSINESS STRATEGY
Continued Rapid Service Rollout. Our strategy is to address the greatest
percentage of our targeted customers as quickly as possible and gain market
share. To accomplish this, during 1999, we plan to expand the coverage of our
network within our existing markets to over 300 central office collocation
sites. During 2000, we plan to expand into approximately 20 new markets and add
over 250 central office collocation sites. Our central office collocation
build-out program is designed to allow us extensive coverage in all the markets
we enter. By positioning ourselves to be the first provider of bundled voice and
data services to small business customers in our markets, we expect to attract
many "early adopter" customers that are interested in high-speed Internet and
data access. See "-- Markets."
Focused Sales and Marketing Effort. To date, we have demonstrated an
ability to sell and provision our services to small business and residential
customers. We achieved this through a direct sales force, vendor programs and
targeted advertising. Our objective for 1999 is to expand significantly our
direct sales force to provide increased sales coverage of our extensive network
footprint. We plan to grow our direct sales force from 66 at March 31, 1999 to
over 130 by year end 1999. Additionally, we will continue developing
relationships with third party agents or vendors as a complement to our direct
sales channels. Our simplified, packaged product set enables us to easily train
our sales force and decreases the time required to market and sell our services.
With the introduction of our bundled voice and data solution, our sales force
can target the small business market segment with a total communications
solution.
Deployment of DSL Solution. We are developing and intend to deploy a
high-speed data solution within our existing network. This solution will
transport multiple voice lines and high-speed data over one unbundled loop using
DSL technology. Our physical presence in ILECs' facilities allows us access to
unbundled loops which is critical to deploying our DSL product set. The
integration of DSL into our existing network is accomplished by installing
advanced equipment in our host switch sites, collocation facilities and customer
sites. This next-generation product is expected to allow us a first-to-market
advantage with a unique product set providing all of a customer's voice and data
needs, billed on one statement from a single source.
Targeting Small Business Users. Based on unbundled loops in service, we
believe the small business customer base is a large and rapidly growing segment
of the communications market in the United States. We target suburban areas of
large metropolitan markets because these areas have high concentrations of small
businesses. By introducing a bundled voice and data solution and placing more
focus on small business sales, we believe we will gain a competitive advantage
over the ILEC, our primary competitor for these customers.
Capital Efficient Network. We were one of the first competitive local
exchange carriers to implement a network strategy of purchasing and installing
switches, collocating in the central offices of the ILEC and leasing the
necessary transport. We believe this network deployment strategy provides a
capital efficient build-out plan and an attractive return on our invested
capital. DSL technology is highly compatible with our existing network and will
allow us to reduce significantly the number of unbundled loops we lease.
Additionally, we are testing a new switching device from Lucent known as
Pathstar(TM). This next generation switch is significantly smaller and less
expensive than the switches we have deployed to date and we envision
installation of this or similar devices in our new markets to extend the
intelligence that determines where to route traffic further into our network. We
expect this decentralized switching approach will allow us greater efficiencies
in our network.
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Sophisticated Operations Support System. We have developed a
comprehensive, proprietary operations support system to manage our business. Our
proprietary system provides integrated features addressing substantially all
aspects of our business, including customer care, billing and collections,
general ledger, payroll, fixed asset tracking, and personnel management. We
believe our system is adaptable to changing circumstances and multiple ILEC
provisioning systems, and can be scaled to support our operations throughout our
planned growth.
Customer Access Control. By connecting the unbundled loop connection from
our customer's site to our central office collocation, we effectively place the
customer on our network. This connection serves as the platform for delivering
our current and future communications services to our customers. Any future
changes our customers want to make to their services, including purchasing more
services from us, are under our direct control. The one exception is for
repairs, which are infrequent but may require the participation of the ILEC's
network maintenance staff.
Timely and Accurate Provisioning for Our Customers. We believe one of the
keys to our success is effectively managing the provisioning process so new
customers are transferred from the ILEC's network to ours in an accurate and
timely fashion. Towards this goal, we have committed significant time and
resources to designing more efficient provisioning processes with each of the
ILECs, particularly automated interfaces. Since 1998, we have been developing
and implementing electronic order interfaces designed to improve provisioning
performance by eliminating manual keying of information and the need to fax
paper orders back and forth. As an illustration, we are finalizing testing of an
interface with BellSouth which provides real-time access to customer information
as well as real-time order entry and confirmation.
As we deploy DSL technology throughout our network, the provisioning
process will become easier for us and more transparent for our customers. With
DSL technology in place, one copper loop will provide enough capacity for
multiple voice and data connections at the customer's premises. Therefore we
will be provisioning far fewer lines, making us significantly less dependent on
the ILEC for placing our customers in service.
Quality Customer Service. We believe providing quality customer service is
essential to offering a superior product to our customers and creating customer
loyalty. A service representative is assigned to each business customer to
coordinate conversion of service and handle any post-installation issues. In
addition, we have a centralized call service center operating 24 hours a day,
seven days a week which handles general billing, customer care and related
issues for all of our customers. The service representatives use our proprietary
operations support system to gain immediate access to our customers' data,
enabling quick responses to customer requests and needs at any time. This system
allows us to present our customers with one fully integrated monthly billing
statement for all communication services.
PRODUCTS AND SERVICES
To date, we have focused on offering basic telephone services to our small
business and residential customers. These services include switched local
dialtone, direct dial long distance and custom calling features such as voice
mail, call waiting and call forwarding. To capitalize on the growing demand of
small business and residential customers for Internet and data services, we
intend to introduce an Internet access portal known as MGCi.com in the second
quarter of this year and
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high-speed data access using DSL technology in some of our markets later this
year. The chart below shows our current offerings and our planned bundled
service solution:
<TABLE>
<CAPTION>
TARGET CUSTOMER CURRENT SERVICE OFFERINGS PLANNED SERVICE OFFERINGS
--------------- ------------------------- -------------------------
<S> <C> <C>
Small Business........... Local Dialtone Local Dialtone
Custom Calling Features Custom Calling Features
Direct Dial Long Distance Direct Dial Long Distance
Inbound 8XX Service
Calling Cards
MGCi.com
High-Speed Data Services
Residential.............. Local Dialtone Local Dialtone
Custom Calling Features Custom Calling Features
Direct Dial Long Distance Direct Dial Long Distance
MGCi.com
High-Speed Data Services
</TABLE>
All of our local services are, and all of our high-speed data services will
be, delivered over our network. Our long distance service is delivered through
resale agreements with various vendors. We offer everyday prices of $.10 per
minute or less for continental United States direct dial long distance calls and
more attractive rates for customers with greater volumes. We bill domestic calls
in six-second increments. To obtain our flat rate long distance prices, a
customer must purchase our local dialtone service. Additionally, we provide
operator and directory services, 911 services and Yellow Page and White Page
listings for our customers through agreements with various ILECs and long
distance carriers in our markets.
MARKETS
We currently operate in Las Vegas, Atlanta, Chicago, southern Florida and
selected areas of southern California, including Los Angeles and San Diego. As
of March 31, 1999, we had 233 central office collocation sites providing access
to approximately 12.8 million addressible lines in these markets. The chart
below shows the distribution of our central office collocation sites within
these markets.
<TABLE>
<CAPTION>
MARKET AREA COLLOCATION SITES ADDRESSABLE LINES
- ----------- ----------------- -----------------
<S> <C> <C>
Southern California.................... 123 7.2 Million
Atlanta................................ 36 1.9 Million
Chicago................................ 39 1.8 Million
Southern Florida....................... 17 1.0 Million
Las Vegas.............................. 18 .9 Million
TOTALS....................... 233 12.8 MILLION
</TABLE>
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During 1999, we plan to expand the coverage of our network within our
existing markets. During 2000, we plan to expand into approximately 20 new
markets. When evaluating new markets, we consider:
- The demographics of the market, specifically the presence of clusters of
ILEC central offices with high concentrations of small business lines. We
have cross-indexed a database of 10 million small businesses against a
database of ILECs' central offices providing unbundled loops to these
businesses to determine the most attractive central office sites for our
future expansion. This research assists in identifying the central
offices which will afford us access to our target customers for bundled
voice and high-speed data services; and
- Our ability to reduce implementation risks by using our existing
relationship with an ILEC to enter new markets within the ILEC's service
territory.
Based on the criteria outlined above, the chart below lists the states and
estimated number of markets we have identified for expansion during 2000 and the
planned time period for the commencement of operations in the first of those
markets. The timing and order of our entering into new markets may vary and will
depend on market conditions, ILEC cooperation and other factors. We cannot
assure you we will begin to offer our services in each of the markets or at the
times indicated below.
<TABLE>
<CAPTION>
NUMBER OF PLANNED
STATE NEW MARKETS OPERATIONAL DATE
----- ----------- ----------------
<S> <C> <C>
California Four First Quarter 2000
Michigan Three First Quarter 2000
Ohio Two First Quarter 2000
Texas Five First Quarter 2000
Wisconsin One First Quarter 2000
Florida Three Second Quarter 2000
Tennessee Two Third Quarter 2000
</TABLE>
SALES AND MARKETING
We concentrate our sales and marketing efforts on users of basic
communications services. We target:
- Small business customers that typically have between three and 24 lines;
- Single family residential users;
- Pay phone operators; and
- Multi-dwelling and multi-business unit owners and managers.
Our highly focused marketing efforts seek to generate well-managed,
profitable growth through increased market share with minimal customer turnover.
Our current sales programs include direct sales efforts, programs with agents
and vendors, telemarketing and targeted advertising.
With the introduction of our bundled voice and high-speed data solution, we
will be putting more emphasis on direct sales to small business prospects. Due
to the simplicity of our bundled voice and data solution, we will not need to
incur extensive costs to retrain our existing sales force.
As of March 31, 1999, we employed 61 local sales personnel and five
national sales personnel. We expect the size of our sales force to increase
substantially during 1999 as we introduce our bundled high-speed data offering.
During the fourth quarter of 1998, we implemented a "team" sales approach in our
Las Vegas market. We plan to implement this approach in each of our local
markets
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<PAGE> 36
during 1999. Each team will consist of two sales representatives, one business
service representative, one telemarketer and one field technician. The
telemarketer and sales representatives will work from lead lists which
specifically identify small business prospects located within the service area
of our collocation sites. The telemarketer will solicit leads and schedule
appointments and, when practical, close sales over the phone. Our business
service representative will act as the liaison between the small business
customer and our operational personnel to effect a coordinated transfer of
service from the ILEC's network to our network. The field technician will be
responsible for the installation of the customer premise equipment. Our national
sales force is responsible for identifying and soliciting owners and managers of
multi-dwelling and multi-business units and pay phone operators.
To complement our local and national sales force, we use established
telephone equipment vendors to market our local and long distance services in
conjunction with equipment sales to business customers. We believe this
distribution channel will become more productive for us in the near future with
the introduction of our bundled voice and high-speed data solution.
NETWORK ARCHITECTURE AND TECHNOLOGY
Network Architecture. In building our network we have implemented a
"smart-build" strategy, building and owning the intelligent components of our
network -- switches and collocation facilities -- while leasing transport from
other common carriers. We use three basic types of transport: first, we lease
unbundled loops which connect a customer to our collocated facilities in an
ILEC's central office; second, we lease local transport which connects our
collocation equipment to our switches; and third, we lease long distance
transport to support our dedicated fully digital, packet switched voice and data
Asynchronous Transfer Mode ("ATM") backbone which connects our switches to each
other and our customers' long distance calls to national and international
destinations. We believe this network strategy provides us an efficient capital
deployment plan and an attractive return on our invested capital.
DSL technology is highly compatible with our existing network and will
allow us to reduce significantly the number of unbundled loops we lease. The
diagram below depicts the configuration of our network in each of our existing
markets.
[artwork of collocation & switches]
We believe leasing unbundled loops, the traditional copper loop connection
from the ILEC's central office to the end user, provides a cost-effective
solution to gaining control of access to the customer. Leasing costs are not
incurred until we have acquired a customer and revenue can be generated.
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<PAGE> 37
It is our experience that the local transport capacity required to connect
our collocation sites to our switches and the long distance transport required
to connect our customers' calls to the Internet or other telephones is available
at reasonable prices in all of our markets. Because local and long distance
transport have become readily available services, we have focused our efforts on
installing and owning switches and collocation facilities and on selling and
provisioning unbundled loops. See "Risk Factors -- We depend on incumbent
carriers for collocation and transmission facilities."
In 1996, we installed our first Nortel DMS-500 digital switch in Las Vegas.
By the end of 1998, we had seven operational DMS-500 switches installed. The
DMS-500 system offers a flexible and cost effective means for us to provide both
local and long distance services. We are currently testing a smaller and less
costly switching device known as Pathstar(TM), developed by Lucent Technologies.
Pathstar(TM) is an ATM switching device that allows us to extend the
intelligence that determines where to route traffic onto our network. This
decentralized switching approach, as opposed to our current installed network
which uses one large switch for multiple collocations, should allow us to make
more efficient use of our network. The early results look promising and we
envision our expansion in 2000 and beyond being supported by Pathstar(TM)-type
switching devices located in our collocation sites which we expect will interact
fully with our current and future DSL equipment. Our seven installed switches
are connected to each other via an ATM transport backbone. ATM is a high-speed
transport technology which carries traffic in fully digital, fixed-length data
packets and allows both voice and data to be transported over a single
connection at high speeds and at reasonable costs. The introduction of DSL
technology into our existing network will create a network where voice and data
are transported exclusively in digital form, from the customer's location to our
collocation and from the collocation to our switch. End-to-end digital transport
will permit us to support more traffic with less incremental cost and, as a
result, should improve operating margins.
To connect our switches to our unbundled loops, we lease local transport
and install collocation equipment in the ILEC's central offices where the
unbundled loops originate and terminate. The installation of this equipment in
the ILEC's central office is referred to as "collocating," "collocations" or
"collocated facilities." Once collocation equipment is installed, we initiate
service to a customer by arranging for the ILEC to physically disconnect the
unbundled loop from its equipment and reconnect the unbundled loop to our
collocation equipment. This connection serves as the platform for delivering our
current and future communications services to our customers because once the
ILEC has connected a customer's unbundled loop to our collocation equipment, we
have direct access to that customer. Any future changes our customers want to
make to their services, including purchasing more services from us, are under
our direct control. The one exception is for repairs, which are infrequent, but
which may require the participation of the ILEC's network maintenance staff.
We have increased our central office collocations from nine as of December
31, 1996 to 233 as of March 31, 1999. We believe the expertise we have developed
in applying for, building and maintaining collocation facilities will allow us
to efficiently handle our planned network expansion including the installation
of collocation equipment required for our planned deployment of DSL technology.
We expect to install DSL equipment at most of our collocation sites during 1999.
We intend to overlay DSL technology into our existing network to provide a
bundled voice and high-speed data solution. This will be accomplished by
installing DSL equipment in our host switch
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<PAGE> 38
sites, collocation sites and at our customers' sites. The diagram below depicts
how our network will be configured after DSL technology is installed in an
existing market.
[DSL technology Flow Chart]
This technology is expected to let us deliver voice and data services over
a single unbundled loop and is expected to provide substantial cost savings as
well as provide significant bandwidth when compared to our current network.
Using DSL technology, we expect to deliver transport speeds of up to 1.5 million
bits per second ("Mbps"), the equivalent of 24 voice grade lines, over a single
traditional copper line. Our DSL equipment will be programmed to allocate the
available bandwidth. For example, voice transmissions are carried at 64 thousand
bits per second ("Kbps"); if a customer has 12 lines (the current configuration
of our equipment installed at our customers' sites) and all are in use
concurrently, then 768 Kbps of the 1.5 Mbps will be allocated for voice
transmission and the remaining 732 Kbps will be available for data transmission.
To ensure the quality of our service offering we intend to initially offer the
service only to customers located within an approximate three-mile radius of a
collocation facility.
We believe this technology, when implemented, will significantly reduce our
customers' implementation risk and our per line transport costs by reducing the
number of unbundled loops which must be leased from, and provisioned by, the
ILEC in order to deliver our services to a customer. For example, if a customer
today has 12 lines, we must order and provision through the ILEC 12 individual
unbundled loops. If the same customer were to connect to our bundled voice and
data package, we would simply convert one of their existing lines to our DSL
equipment, provide the same number of voice circuits to the customer and notify
the ILEC to cancel the remaining 11 unbundled loops. Also, we expect that future
additional products and services designed around the increased bandwidth
provided by DSL technology will generate incremental revenue with attractive
margins.
Interconnection Agreements and CLEC Certifications. We have
interconnection agreements with Sprint for Nevada, BellSouth for Georgia and
Florida, GTE and PacBell for California and Ameritech for Illinois. These
agreements expire on various dates through July 2000. We are certified as a CLEC
in Illinois, Georgia, Nevada, California, Florida and Massachusetts.
DSL Equipment Vendors. To deploy DSL technology in our existing network,
we have executed, or are in the process of negotiating, agreements with multiple
vendors for the purchase of DSL equipment which will be installed at our host
switch sites, collocation facilities and customer sites. To maximize the
flexibility of our network architecture, equipment costs and product offerings
to customers, we are working with various DSL equipment vendors. These vendors
include sole source manufacturers which can provide proprietary equipment for
all of our DSL needs and vendors who manufacture components only, such as
manufacturers of the equipment required at our collocation facilities and
manufacturers of customer premise equipment. The component DSL
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<PAGE> 39
equipment is compatible with DSL equipment provided by other manufacturers and
with our current DMS-500 switches and planned ATM switches. Because the DSL
technology employed by each DSL vendor we are working with is standard, our
ultimate selection of a DSL equipment vendor or vendors will be based on a
number of factors, including network and operating flexibility and economic
issues. All of the vendors we are currently working with have indicated they are
capable of providing the functionality we plan to offer as a product to our
targeted customers.
SERVICE DEPLOYMENT AND OPERATIONS
Customer Service. We strive to provide high quality customer service
through:
- Personnel. Our customer service representatives and sales personnel are
well trained and attentive to our customers' needs.
- Call Center. Our centralized customer service center in Las Vegas
operates 24 hours a day, seven days a week. Calls from our customers are
answered and responded to with minimal wait time.
- Coordination of Service Provisioning. We coordinate service installation
with our customer and the ILEC to ensure a smooth transition of services
from the ILEC to us.
- Close Customer Contact. We proactively monitor our network and keep our
customers informed of installation or repair problems and allocate the
necessary resources to resolve any problems.
- Billing. We provide our customers with accurate, timely and easily
understood bills.
Process Automation. We have developed a comprehensive operations support
system to manage our business. This proprietary system provides integrated
features addressing substantially all aspects of our business including customer
care, billing and collections, general ledger, payroll, fixed asset tracking and
personnel management. In addition, in 1998, to improve provisioning performance,
we began developing electronic interfaces with five ILECs to reduce the need to
manually process orders.
When a new customer orders our service, we track the progress of the order
with electronic or fax updates from the ILEC. Our installation personnel follow
the customer's order, seeking to ensure the installation date is met.
Additionally, customer service representatives are able to handle all other
customer service inquiries, including billing questions and repair calls, with
the information available from our integrated system.
The billing component of our operations support system is designed to track
and bill all forms of local service, including line and feature charges as well
as long distance charges. We can accommodate business customers desiring a
single bill for many locations, summary bills without detail or a number of
other types of customized bills. We can deliver bills to our customers in a
number of alternative media including electronic files and during 1999, on-line
inquiry through our Website.
GOVERNMENT REGULATIONS
Overview
Our services are regulated at the federal, state and local level. The FCC
exercises jurisdiction over all facilities of, and services offered by,
communications common carriers like us, as long as those facilities are used in
connection with interstate or international communications. State regulatory
commissions have some jurisdiction over most of the same facilities and services
if they are used in connection with communications within states. Many of the
regulations issued by these federal and state agencies may be reviewed by
courts, the results of which we are unable to predict.
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<PAGE> 40
Federal Regulation
The FCC regulates interstate and international communications services,
including the use of local telephone facilities to place and receive interstate
and international calls. We provide these services as a common carrier. The FCC
imposes regulations on common carriers such as the ILECs, that have some degree
of market power. The FCC imposes less regulation on common carriers without
market power including, to date, CLECs like us. The FCC requires all common
carriers to receive an authorization to construct and operate communications
facilities, and to provide or resell communications services, between the United
States and international points.
The Telecommunications Act permits virtually any entity, including cable
television companies and electric and gas utilities, to enter any communications
market. The Telecommunications Act takes precedence over inconsistent state
regulation. However, entities that enter communications markets must follow
state regulations relating to safety, quality and consumer protection.
Implementation of the Telecommunications Act may be affected by numerous federal
and state policy rulemaking proceedings and review by courts. We are uncertain
as to how our business may be affected by these proceedings.
The Telecommunications Act is intended to promote competition. The
Telecommunications Act opens the local services market to competition by
requiring ILECs to permit interconnection to their networks and by establishing
ILEC and CLEC obligations with respect to:
Reciprocal Compensation. All ILECs and CLECs are currently required
to complete calls originated by each other under reciprocal arrangements at
prices based on tariffs or negotiated prices.
Resale. All ILECs and CLECs are required to permit resale of their
communications services without unreasonable restrictions or conditions. In
addition, ILECs are required to offer wholesale versions of all retail
services to other common carriers for resale at discounted rates, based on
the costs avoided by the ILEC by offering these services at wholesale
rates.
Interconnection. All ILECs and CLECs are required to permit their
competitors to interconnect with their facilities. All ILECs are required
to permit interconnection at any feasible point within their networks, on
nondiscriminatory terms, at prices based on cost, which may include a
reasonable profit. At the option of the carrier requesting interconnection,
collocation of the requesting carrier's equipment in the ILECs' premises
must be offered.
Unbundled Access. All ILECs are required to provide access to
unbundled network elements on nondiscriminatory terms and at prices based
on cost, which may include a reasonable profit.
Number Portability. All ILECs and CLECs are required to permit users
of communications services to retain their existing telephone numbers
without impairment of quality, reliability or convenience when switching
from one common carrier to another.
Dialing Parity. All ILECs and CLECs are required to provide "l+"
equal access to competing providers of long distance service, and to
provide nondiscriminatory access to telephone numbers, operator services,
directory assistance and directory listing, with no unreasonable dialing
delays.
Access to Rights-of-Way. All ILECs and CLECs are required to permit
competing carriers access to their poles, ducts, conduits and rights-of-way
at regulated prices.
ILECs are required to negotiate in good faith with carriers requesting any
or all of the above arrangements. If the negotiating carriers cannot reach
agreement within a predetermined amount of time, either carrier may request
arbitration of the disputed issues by the state regulatory commission.
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Where an agreement has not been reached, ILECs continue to have interconnection
obligations established by the FCC and state regulatory commissions.
In August 1996, the FCC established rules to implement the ILEC
interconnection obligations described above. On July 18, 1997, a United States
appeals court overturned portions of these rules and narrowly interpreted the
FCC's power to establish and enforce rules implementing the Telecommunications
Act. On January 25, 1999, the United States Supreme Court reversed the appeals
court decision and confirmed the FCC's broad authority to issue rules
implementing the Telecommunications Act. Specifically, the Supreme Court decided
that:
- the FCC has jurisdiction over pricing of unbundled network elements; and
- the FCC has authority to make rules allowing a CLEC to "pick and choose"
among the most favorable terms from existing agreements between an ILEC
and other CLECs.
On the other hand, the Supreme Court vacated an FCC rule which described
the network elements the ILECs must provide to competitors on an unbundled
basis. This required the FCC to re-examine its rules regarding which unbundled
network elements must be made available to competitors. The FCC subsequently
opened an administrative proceeding to examine its rules in light of the Supreme
Court's January 25, 1999 interpretation, and tentatively concluded that
unbundled loops, the element most important to our business, must continue to be
made available to CLECs like us. This conclusion is not final, and even when
finalized, this and the rest of the FCC's conclusions may be further reviewed by
courts. We expect the FCC to render a final decision by the end of 1999.
We have taken the steps necessary to be a provider of local dialtone
services, and we have obtained CLEC certification in six states. In addition, we
have successfully negotiated interconnection agreements with five ILECs. In some
cases, one or both parties may be entitled to demand renegotiation of particular
provisions in an agreement based on intervening changes in the law. It is
uncertain whether we will be able to renew these agreements on favorable terms
when they expire. Some of the rates in these interconnection agreements have
been established by the FCC and may be adjusted by subsequent negotiations
between the parties. For example, the rates we pay Sprint (Nevada) for unbundled
network elements are in dispute. In this situation, we have recorded unbundled
network element expenses using our best estimate of the probable outcome for the
final negotiated rates. We believe the resolution of this matter will not have a
material adverse effect on our financial position, results of operations or
liquidity.
The Telecommunications Act also contains special provisions that replace
prior antitrust restrictions that prohibited the regional Bell operating
companies from providing long distance services and engaging in communications
equipment manufacturing. Prior to the passage of the Telecommunications Act, the
regional Bell operating companies and the dominant ILECs were restricted to
providing services within a distinct geographical area known as a Local Access
and Transport Area ("LATA"). After the breakup of the Bell system, the country
was divided into LATAs. Under this system, regional Bell operating companies
could only provide local service within their LATA. The Telecommunications Act
changed this system. The Telecommunications Act permits the regional Bell
operating companies to provide long distance service in their market region once
they have satisfied several procedural and substantive requirements, including:
- a showing that the regional Bell operating company is subject to
meaningful competition; and
- a determination that the regional Bell operating company's entry into
long distance markets is in the public interest.
No request by a regional Bell operating company to offer long distance
services in its own market region has been approved by the FCC as of May 7,
1999. However, additional requests will
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<PAGE> 42
likely be filed in 1999 and may receive approval, allowing regional Bell
operating companies to offer long distance services in one or more of our
markets. This may have an unfavorable effect on our business.
Two regional Bell operating companies, US West and Ameritech, entered into
"teaming agreements" with Qwest Communications International, Inc. ("Qwest"),
under which these regional Bell operating companies would solicit their
customers for Qwest's long distance service and handle billing of those
customers in exchange for a fee. These agreements would have permitted the
regional Bell operating companies to compete with us by offering their local
customers a package of local and long distance services, even though the
regional Bell operating companies would not themselves be providing the long
distance element of these services. We joined other carriers in requesting that
the FCC block this proposed arrangement and we commenced litigation in federal
courts to block the proposed arrangement. The courts, at the request of the FCC,
referred the question of the legality of the agreements under the
Telecommunications Act to the FCC. On October 7, 1998, the FCC released a
decision that these agreements were an improper attempt by the regional Bell
operating companies to provide long distance service between LATAs that would be
inconsistent with the Telecommunications Act. The FCC's decision has been
appealed to the federal courts.
The FCC is also considering a regional Bell operating company proposal to
permit regional Bell operating companies to eventually offer high-speed data
services between LATAs through a separate subsidiary, without first having to
demonstrate that they have met the FCC procedural and substantive requirements
referred to above.
With respect to our domestic and international service offerings, we have
filed tariffs with the FCC stating the rates, terms and conditions for our
interstate and international services. Our interstate tariffs are subject to
"streamlined" tariff regulations and are generally not reviewed by the FCC
before becoming effective. Our tariffs can be amended on one day's notice. With
limited exceptions, the FCC currently requires ILECs to charge all customers the
same price for the same service. The FCC may, however, permit ILECs to offer
special rate packages to very large customers, as it has done in a few cases, or
permit other forms of rate flexibility. The FCC has adopted some proposals that
significantly lessen the regulation of ILECs which encounter competition in
their service areas and provide these ILECs with additional flexibility in
pricing their services.
In two orders released on December 24, l996 and May 16, 1997, the FCC made
major changes in the structure of interstate access charges. The December 24th
order permits ILECs to lower access charges. The May 16th order grants ILECs
increased pricing flexibility subject to the FCC's price cap rules upon
demonstrations of increased competition or potential competition in their
markets. The manner in which these changes are implemented could have a material
effect on the amount of switched access charges we collect from long distance
carriers. Several parties appealed the May 16th order. On August 19, 1998, the
May 16th order was affirmed by a United States appeals court. The FCC is now
considering public comments on a pricing flexibility proposal submitted by two
regional Bell operating companies and on modifying the factors the FCC uses to
determine annual price cap adjustments. In addition, on May 21, 1999, a United
States court of appeals reversed an FCC order that had established the factors
that are currently used to set the annual price cap. The court ordered the FCC
to further explain the methodology it used in establishing those factors.
ILECs have been contesting whether their obligation to pay reciprocal
compensation to CLECs should apply to local telephone calls from an ILEC's
customers to Internet service providers served by CLECs. The ILECs claim this
traffic is interstate in nature and should be exempt from reciprocal
compensation arrangements applicable to local and intrastate calls. CLECs have
contended that their interconnection agreements with ILECs provide no exception
for local calls to Internet service providers and reciprocal compensation is
applicable.
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<PAGE> 43
On February 26, 1999, the FCC ruled that Internet service provider traffic
is within the FCC's jurisdiction but that its current rules neither require nor
prohibit the payment of reciprocal compensation for these calls. The FCC
determined that state commissions have authority to interpret and enforce the
reciprocal compensation provisions of existing interconnection agreements and to
determine the appropriate treatment of Internet service provider traffic in
arbitrating new agreements. The FCC also requested comment on federal rules to
govern compensation for these calls in the future.
Currently, 29 state commissions and several federal and state courts have
ruled that reciprocal compensation arrangements apply to calls to Internet
service providers. However, one state has ruled that reciprocal compensation
arrangements are not applicable to calls to Internet service providers. Some
regional Bell operating companies have asked state commissions to reopen
decisions requiring the payment of reciprocal compensation on Internet service
provider calls. Additional disputes over the appropriate treatment of Internet
service provider traffic are pending.
Internet service providers may be among our potential customers and adverse
decisions in state proceedings could limit our ability to service this group of
customers profitably. However, at the present time, we do not focus our
marketing efforts on Internet service providers. Given the uncertainty as to
whether reciprocal compensation is payable in connection with calls to Internet
service providers, we do not recognize revenue from calls to Internet service
providers.
On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy program. Several parties have
appealed this order. The appeals have been consolidated and transferred to a
United States appeals court where they are currently pending. The FCC's May 8,
1997 order established new subsidies for telecommunications and information
services provided to qualifying schools and libraries with an annual cap of
$2.25 billion and for services provided to rural health care providers with an
annual cap of $400 million. The FCC also expanded federal subsidies for local
dialtone services provided to low-income consumers. Providers of interstate
telecommunications service, such as us, must contribute to these programs. We
intend to recover these costs through charges assessed directly to our customers
and participation in federally subsidized programs. The net financial effect of
these regulations on us cannot be determined at this time. Currently, the FCC is
assessing contributions to these programs on the basis of a provider's revenue
for the previous year. The FCC announced that it intends, effective July 1,
1999, to revise its rules for subsidizing service provided to consumers in high
cost areas, which may result in further substantial increases in the cost of the
subsidy program.
State Regulation
The implementation of the Telecommunications Act is subject to numerous
state rulemaking proceedings. As a result, it is currently difficult to predict
how quickly full competition for local services, including local dialtone, will
be introduced.
To provide services within a state, we generally must obtain a certificate
of public convenience and necessity from the state regulatory agency and comply
with state requirements for telecommunications utilities, including state
tariffing requirements. To date, we have satisfied state requirements to provide
local and intrastate long distance service in Nevada, Georgia, Illinois,
California, Florida and Massachusetts.
State regulatory agencies have jurisdiction over our facilities and
services used to provide intrastate services. State agencies require us to file
periodic reports, pay various fees and assessments and comply with rules
governing quality of service, consumer protection and similar issues. The
specific requirements vary from state to state. Price cap or rate of return
regulation does not apply in any of our current or planned expansion markets.
However, we cannot assure you that the imposition
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<PAGE> 44
of new regulatory burdens in a particular state will not affect the
profitability of our services in that state.
Local Regulation
Our networks must comply with numerous local regulations such as building
codes, municipal franchise requirements and licensing. These regulations vary on
a city by city and county by county basis. In some of the areas where we provide
service, we may have to comply with municipal franchise requirements and may be
required to pay license or franchise fees based on a percentage of gross revenue
or other factors. Municipalities that do not currently impose fees may seek to
impose fees in the future. We cannot assure you fees will remain at their
current levels following the expiration of existing franchises.
COMPETITION
The communications industry is highly competitive. We believe the principal
competitive factors affecting our business will be pricing levels and policies,
transmission speed, customer service, breadth of service availability, network
security, ease of access and use, content bundling, brand recognition, operating
experience, capital availability, exclusive contracts, accurate billing and
variety of services. To maintain our competitive posture, we believe we must be
in a position to reduce our prices to meet any reductions in rates by our
competitors. Any reductions could adversely affect us. Many of our current and
potential competitors have financial, personnel and other resources, including
brand name recognition, substantially greater than ours, as well as other
competitive advantages over us. In addition, competitive alternatives may result
in substantial customer turnover in the future. Many providers of communications
and networking services experience high rates of customer turnover.
A continuing trend toward consolidation of communications companies and the
formation of strategic alliances within the communications industry, as well as
the development of new technologies, could give rise to significant new
competitors to us. For example, WorldCom acquired MFS Communications in December
1996, acquired another CLEC, Brooks Fiber Properties, Inc., in 1997, and
recently merged with MCI. AT&T recently acquired Teleport Communications Group
Inc., a CLEC, and TeleCommunications, Inc., a cable, communications and
high-speed Internet services provider, and recently announced its intent to
merge with MediaOne. Ameritech Corporation has agreed to merge with SBC
Communications and Bell Atlantic has agreed to merge with GTE Corporation. These
types of consolidations and strategic alliances could put us at a competitive
disadvantage.
LOCAL DIALTONE SERVICES
Incumbent Local Exchange Carriers
In each of the markets we target, we will compete principally with the ILEC
serving that area. We believe the regional Bell operating companies are
aggressively seeking to be able to offer long distance service in their service
territories. Many experts expect one or more of the regional Bell operating
companies to be successful in entering the long distance market during 1999. We
believe the regional Bell operating companies expect to offset losses of market
share in their local markets by attempting to capture a large percentage of the
long distance market in their market areas, especially among residential users
where their strong regional brand names and extensive advertising campaigns may
be very successful. In addition, a continuing trend toward business combinations
and alliances in the communications industry may create significant new
competitors for us.
We have not achieved and do not expect to achieve a significant market
share for any of our services. The ILECs have long-standing relationships with
their customers, have financial, technical and marketing resources substantially
greater than ours, have the potential to subsidize competitive
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<PAGE> 45
services with revenues from a variety of businesses and currently benefit from
existing regulations that favor the ILECs over us in some respects. While recent
regulatory initiatives which allow CLECs such as us to interconnect with ILEC
facilities provide increased business opportunities for us, interconnection
opportunities have been and likely will continue to be accompanied by increased
pricing flexibility for, and relaxation of regulatory oversight of, the ILECs.
ILECs have long-standing relationships with regulatory authorities at the
federal and state levels. The FCC recently proposed a rule that would provide
for increased ILEC pricing flexibility and deregulation for competitive access
services, either automatically or after competitive levels are reached. If the
ILECs are allowed by regulators to offer discounts to large customers through
contract tariffs, engage in aggressive volume and term discount pricing
practices for their customers, and/or seek to charge competitors excessive fees
for interconnection to their networks, our operating margins could be materially
adversely affected. Future regulatory decisions which give the ILECs increased
pricing flexibility or other regulatory relief could also have a material
adverse effect on us.
Competitive Local Exchange Carriers/Long Distance Carriers/Other Market
Entrants.
We face, and expect to continue to face, competition from long distance
carriers, such as AT&T, MCI WorldCom, and Sprint, seeking to enter, reenter or
expand entry into the local exchange market. We also compete with other CLECs,
resellers of local dialtone services, cable television companies, electric
utilities, microwave carriers, wireless telephone system operators and large
customers.
The Telecommunications Act includes provisions which impose regulatory
requirements on all ILECs and CLECs but grants the FCC expanded authority to
reduce the level of regulation applicable to these common carriers. The manner
in which these provisions of the Telecommunications Act are implemented and
enforced could have a material adverse effect on our ability to successfully
compete against ILECs and other communications service providers.
The Telecommunications Act radically altered the market opportunity for
CLECs. Many existing CLECs which entered the market before 1996 had to build a
fiber infrastructure before offering services. With the Telecommunications Act
requiring unbundling of the ILEC networks, CLECs are now able to more rapidly
enter the market by installing switches and leasing transport and unbundled loop
capacity.
A number of CLECs have entered or announced their intention to enter one or
more of our markets. We believe that not all CLECs, however, are pursuing the
same target customers as us. We intend to keep our prices at levels below those
of the ILECs while providing, in our opinion, a higher level of service and
responsiveness to our customers. Innovative packaging and pricing of basic
telephone services is expected to provide competitive differentiation for us in
each of our markets.
LONG DISTANCE SERVICES
The long distance services industry is very competitive and many long
distance providers experience a high average turnover rate as customers
frequently change long distance providers in response to offerings of lower
rates or promotional incentives by competitors. Prices in the long distance
market have declined significantly in recent years and are expected to continue
to decline. We expect to face increasing competition from companies offering
long distance data and voice services over the Internet. Companies offering
these services over the Internet could enjoy a significant cost advantage
because they do not currently pay common carrier access charges or universal
service fees.
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<PAGE> 46
DATA AND INTERNET SERVICES
We expect the level of competition with respect to data and Internet
services to intensify in the future. We expect significant competition from:
- ILECs. Most ILECs have announced deployment of commercial DSL services.
Some ILECs have announced they intend to aggressively market these
services to their residential customers at attractive prices. In
addition, most ILECs are combining their DSL service with their own
Internet service provider businesses. We believe ILECs have the potential
to quickly overcome many of the issues that have delayed widespread
deployment of DSL services in the past. The ILECs have an established
brand name in their service areas, possess sufficient capital to deploy
DSL services rapidly and are in a position to offer service from central
offices where we may be unable to secure collocation space. If a regional
Bell operating company is authorized to provide long distance service, by
fulfilling the requirements of the Telecommunications Act, the regional
Bell operating company may be able to offer "one stop shopping" that
would be competitive with our offerings.
- Traditional Long Distance Carriers. Many of the leading traditional long
distance carriers, such as AT&T, MCI WorldCom and Sprint, are expanding
their capabilities to support high-speed, end-to-end networking services.
We expect them to offer combined data, voice and video services over
their networks. These carriers have extensive fiber networks in many
metropolitan areas that primarily provide high-speed data and voice
services to large companies. They could deploy DSL services in
combination with their current fiber networks. They also have
interconnection agreements with many ILECs and have secured collocation
space from which they could begin to offer competitive DSL services.
- Newer Long Distance Carriers. The newer long distance carriers, such as
Williams Communications, Qwest Communications International and Level 3
Communications, are building and managing high-speed networks nationwide.
They are also building direct sales forces and partnering with Internet
service providers to offer services directly to business customers. They
could extend their existing networks and offer high-speed services using
DSL, either alone or in partnership with others.
- Cable Modem Service Providers. Cable modem service providers, like @Home
Networks and its cable partners, are offering, or are preparing to offer,
high-speed Internet access over cable networks to consumers. @Work has
positioned itself to do the same for businesses. These networks provide
high-speed data services similar to our services, and in some cases at
higher speeds. These companies use a variety of new and emerging
technologies, such as point-to-point and point-to-multipoint wireless
services, satellite-based networking and high-speed wireless digital
communications.
- Competitive Carriers. Carriers, including Covad Communications Group,
Inc., Rhythms NetConnections Inc. and NorthPoint Communications, Inc.,
have begun offering DSL services and have strategic equity investors,
marketing alliances and product development partners.
Many of these competitors are offering, or may soon offer, DSL technologies
and services that will directly compete with us. Please see "Risk Factors -- The
market in which we operate is highly competitive and we may not be able to
compete effectively, especially against established industry competitors with
significantly greater financial resources."
PROPERTY
In Las Vegas, we have a five year lease (expiring in 2001) with a five year
option for the site housing our switch. We also lease space in Las Vegas for our
corporate headquarters, national customer service operations, national sales
personnel, Las Vegas sales personnel and general
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<PAGE> 47
administration. This lease expires in 2003. This facility is owned by a limited
liability company which is principally owned by two of our principal
stockholders and directors, Maurice J. Gallagher, Jr. and Timothy P. Flynn.
We also own property housing our switch facilities in Ontario, Long Beach,
San Diego, Chicago and Fort Lauderdale. Our switch site in Atlanta has been
leased for a term expiring in 2007 with renewal options. We have leased
facilities to house our local sales and administration staff in each market.
We place great importance on each switch facility and seek to insure
maximum security and environmental control. We also believe this can be achieved
most effectively through stand-alone structures. This approach minimizes the
risk of fire or other hazards from adjacent tenants or properties.
PERSONNEL
As of March 31, 1999, we had 488 employees, most of whom were located in
Las Vegas. We expect to substantially increase the number of our employees over
the next two years.
We have non-disclosure and non-compete agreements with all of our executive
employees. None of our employees are represented by a collective bargaining
agreement.
LEGAL PROCEEDINGS
We are party to numerous state and federal administrative proceedings. In
these proceedings, we are seeking to define and/or enforce ILEC performance
requirements related to:
- the cost and provisioning of unbundled network elements;
- the establishment of customer care and provisioning;
- the allocation of subsidies; and
- collocation costs and procedures.
The outcome of these proceedings will establish the rates and procedures by
which we obtain and provide unbundled network elements and could have a material
effect on our operating costs.
We are also involved in legal proceedings in which we are seeking to
enforce our tariffed rates for originating and terminating long distance calls.
As of March 31, 1999, we had outstanding receivables of approximately $5.6
million attributable to access charges from AT&T, Sprint and MCI WorldCom. These
long distance carriers have refused to pay the full amount of the access charges
billed to them. We have initiated proceedings against AT&T at the FCC under an
FCC procedure for expedited settlement of disputes between common carriers. On
July 16, 1999, the FCC released a decision ordering AT&T to pay us the full
amount we billed to them for originating switched access charges from August
1998 through March 1999 at our tariffed rate, plus interest. This decision is
subject to appeal by AT&T to a federal appeals court. We are currently
negotiating with Sprint and MCI WorldCom and have submitted our dispute with MCI
WorldCom to arbitration. The final outcome of the disputes with AT&T, Sprint and
MCI WorldCom is uncertain. If we are unable to collect our tarriffed access
charges from these long distance carriers, it could have a material impact on
our financial condition. See "Risk Factors -- The access charges we collect from
long distance carriers may be reduced as a result of regulatory challenges."
From time to time, we engage in other litigation and governmental
proceedings in the ordinary course of our business. We do not believe any
pending litigation or governmental proceedings will have a material adverse
effect on our results of operations or financial condition.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
Our executive officers and directors, and their respective ages as of May
15, 1999, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Maurice J. Gallagher, Jr.................... 49 Chairman of the Board of Directors
Nield J. Montgomery......................... 54 Chief Executive Officer, President, Director
Timothy P. Flynn(1)......................... 48 Director
Jack L. Hancock(2).......................... 69 Director
David Kronfeld.............................. 51 Director
Thomas Neustaetter(1)(2).................... 47 Director
Paul J. Salem(1)(2)......................... 35 Director
John Boersma................................ 38 Senior Vice President -- Operations
Michael E. Burke............................ 54 Vice President -- Network Operations
David S. Clark.............................. 38 Senior Vice President -- Sales and Marketing
Kent F. Heyman.............................. 43 Vice President and General Counsel
James J. Hurley, III........................ 50 President -- Midwest Region
James Mitchell.............................. 38 President -- Eastern Region
Mark W. Peterson............................ 44 President -- Western Region
Linda M. Sunbury............................ 37 Senior Vice President and Chief Financial
Officer
</TABLE>
- -------------------------
(1) Member of Audit Committee.
(2) Member of Compensation Committee.
MAURICE J. GALLAGHER, JR. has served as the Chairman of our Board of
Directors since our inception. Mr. Gallagher was instrumental in organizing the
Company with Mr. Montgomery. Mr. Gallagher was a founder of ValuJet Airlines,
Inc. ("ValuJet") in 1993 and served as a director of ValuJet from 1993 until
November 1997. Mr. Gallagher also held prior positions (including Chief
Financial Officer) with ValuJet from 1993 to 1994 and served as Vice Chairman
from 1994 to 1997. Prior to ValuJet, Mr. Gallagher was a founder and President
of WestAir Holding, Inc. ("WestAir"), a commuter airline headquartered in
Fresno, California. WestAir was sold to Mesa Airlines ("Mesa") in June 1992. Mr.
Gallagher was a member of the Mesa board of directors from June 1992 through
March 1993.
NIELD J. MONTGOMERY has been our Chief Executive Officer and President and
a member of our Board of Directors since our founding. Mr. Montgomery has over
36 years of telephone experience, most recently serving as a general manager for
ICG Telecom Group, Inc. ("ICG Telecom") from April 1994 to June 1995. In that
capacity, he was responsible for developing strategy and deploying telephone
switches nationally to position ICG Telecom to enter the local phone service
business. Prior to that, Mr. Montgomery served as General Marketing and Sales
Manager for Sprint/Centel (successor to Centel Nevada) ("Centel"). During his 13
year Centel career from 1980 to 1993, he served in senior executive positions
directing engineering, operations, business office, sales, and marketing
functions. Before joining Centel, Mr. Montgomery held a variety of management
positions with NYNEX from 1969 to 1980.
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<PAGE> 49
TIMOTHY P. FLYNN has served as a member of our Board of Directors since
1996. Mr. Flynn served as a member of the board of directors of ValuJet since he
participated in its founding in 1993 until November 1997. Prior to ValuJet, Mr.
Flynn was Chairman of the Board and CEO of WestAir. He and Mr. Gallagher
purchased WestAir in 1983 and operated it through June 1992 when it was sold to
Mesa. Mr. Flynn was a member of the board of directors of Mesa from June 1992
through March 1993. Mr. Flynn and Mr. Gallagher are affiliated in a number of
other transactions.
JACK L. HANCOCK has served as a member of our Board of Directors since
1996. Mr. Hancock was Vice President of Systems Technology and Executive Vice
President, Product and Technology for PacBell (from 1988 to 1993). He is a
member of the boards of directors of Union Bank of California (from 1994 to
present) and Wittaker Corporation (from 1994 to present).
DAVID KRONFELD was elected to serve as a member of our Board of Directors
in February 1998. Mr. Kronfeld is the founder of JK&B Management, L.L.C., a
venture capital firm, and has managed its affairs since 1995. Since 1989, Mr.
Kronfeld has also been a partner at Boston Capital Ventures, a venture capital
firm where he specialized in the telecommunications and software industries.
THOMAS NEUSTAETTER was elected to serve as a member of our Board of
Directors in February 1998. Since January 1996, Mr. Neustaetter has been a
principal of The Chatterjee Group ("TCG"), an investment firm. Prior to TCG, he
was managing director and founder of Bancroft Capital (financial advisory
services) from January 1996 to December 1996 and was a managing director at
Chemical Bank from 1990 to 1995. Mr. Neustaetter serves as a director of 21st
Century Telecom Group, Inc.
PAUL J. SALEM was elected to serve as a member of our Board of Directors in
May 1999. Since 1997, Mr. Salem served as a managing director of Providence
Equity Partners, Inc., which provides investment management services to
Providence Equity Partners III L.P. ("PEP") and has since its founding in 1998
served as a member of Providence Equity Partners III LLC, the general partner of
PEP. Mr. Salem also served as a Vice President of Providence Ventures Inc. from
1992 to 1996. Mr. Salem has served as a director of MetroNet Communications
Corp. since July 1996 and as a director of Verio, Inc. since 1996.
JOHN BOERSMA has served as our Vice President -- Operations since May 1997
and was designated Senior Vice President -- Operations in May 1999. He served as
Vice President of Carrier Relations for ICG Telecom Group, Inc. from 1996 to
1997. In that capacity, he was responsible for ICG Telecom's relationship with
local exchange carriers and implementation, purchase agreements and service
quality. Mr. Boersma served as Vice President, Northern California Operations of
ICG Telecom from April 1994 to September 1996.
MICHAEL E. BURKE has served as our Vice President -- Network Operations
since 1996. Mr. Burke has over 28 years of engineering and engineering project
management experience in the telecommunications industry, and served from 1990
to 1995 as a member of the Board of Directors and as Vice President -- Network
Design for Contel of California. Mr. Burke also served in various engineering
management roles with Continental Telephone Company from 1971 to 1995.
DAVID S. CLARK has served as our Vice President -- Marketing since May 1997
and was designated Senior Vice President -- Sales and Marketing in May 1999. Mr.
Clark has been in the telecommunications industry for 10 years, with
responsibilities including engineering, purchasing, product development, client
acquisition and maintenance, marketing and advertising. From 1989 to 1997, Mr.
Clark was employed by North American Telecom, his last position being Vice
President of Communications Services.
KENT F. HEYMAN has served as our Vice President and General Counsel since
June 1996. Mr. Heyman has 18 years of legal experience, most recently as
chairman of the litigation department and Senior Trial Counsel of the Dowling,
Magarian, Aaron & Heyman Law Firm. Mr. Heyman has
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<PAGE> 50
served as a California Superior Court Judge pro tempore presiding over trial,
settlement conference and other proceedings from 1990 to 1996.
JAMES J. HURLEY III has served as our President -- Midwest Region since
March 1998. He previously served as Chief Operating Officer of Wireless Works,
Inc. in Chicago, Illinois from 1996 to 1998. From 1992 to 1996, Mr. Hurley was
President and Chief Executive Officer of Inn Room Systems, Inc. (a manufacturer
of on-line room refreshment centers).
JAMES MITCHELL has served as our President -- Eastern Region since February
1998. Mr. Mitchell has over nine years of telephone industry experience, serving
from 1990 to 1998 in various sales and marketing management roles with MCI, his
last position being Regional Sales and Marketing Manager for the Southeast
Region.
MARK W. PETERSON has served as our President -- Western Region since March
1997. From 1993 to 1996, Mr. Peterson was a marketing and communications
consultant and a law student. He previously served as head of corporate affairs
for WestAir Holding, Inc. operating as United Express in Fresno, California from
1988 to 1992.
LINDA M. SUNBURY has served as our Vice President since June 1996 and our
Chief Financial Officer since January 1998. Ms. Sunbury was designated Senior
Vice President in May 1999. Ms. Sunbury has over 15 years accounting and
administrative experience, having held similar positions in the airline
industry. Most recently, Ms. Sunbury was Vice President of Administration for
Business Express, Inc. ("Business Express") dba the Delta Connection from 1994
to 1996. While Ms. Sunbury was at Business Express, creditors of Business
Express filed an involuntary petition for bankruptcy in January 1996. Business
Express subsequently reorganized and emerged from bankruptcy in April 1997.
Prior to that, Ms. Sunbury served as Controller for WestAir from 1988 to 1994.
Messrs. Kronfeld and Neustaetter were initially selected to serve on our
Board of Directors by the holders of our Series A Convertible Preferred Stock.
The Series A Convertible Preferred Stock was automatically converted into common
stock upon our initial public offering.
Mr. Salem was selected to serve on our Board of Directors by the holders of
our Series B Convertible Preferred Stock.
We are currently in the process of searching for an individual who will
serve as our chief executive officer and/or chief operating officer. We have
engaged an executive search firm to assist us in this process. It is currently
anticipated that Nield Montgomery will continue to serve in a senior executive
position after the employment of the new executive but that his responsibilities
will be modified to accommodate the responsibilities of the new executive. We
cannot assure you that we will be able to hire a new chief executive officer or
chief operating officer upon terms acceptable to us. See "Risk Factors -- Our
success depends on the effectiveness of our management and we are seeking to
make changes to our management team."
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<PAGE> 51
PRINCIPAL AND SELLING STOCKHOLDERS
SECURITY OWNERSHIP OF MANAGEMENT AND BENEFICIAL OWNERS
The following table shows information known to us with respect to
beneficial ownership of common stock as of May 17, 1999, by (A) each director,
(B) all executive officers and directors as a group and (C) each person known by
us to be a beneficial owner of more than 5% of our outstanding common stock.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT OF
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) OWNERSHIP(1)
- ------------------------ --------------------- ------------
<S> <C> <C>
Providence Equity Partners III LLC(2).................. 4,166,667 19.2%
Maurice J. Gallagher, Jr.(3)........................... 3,274,108 18.7%
David Kronfeld(4)...................................... 1,703,927 9.4%
Wind Point Investors, L.L.C.(5)........................ 1,241,270 6.9%
West Highland Capital, Inc.(6)......................... 1,012,100 5.8%
Nield J. Montgomery(7)................................. 952,500 5.4%
Timothy P. Flynn(8).................................... 899,700 5.1%
Thomas Neustaetter(9).................................. 694,514 4.0%
Jack L. Hancock(10).................................... 37,200 *
Paul J. Salem(11)...................................... -- --
All Executive Officers and Directors as a Group (15
persons) (3)(4)(7)(8)(9)(10)(11)(12)................. 8,088,289 43.8%
</TABLE>
- -------------------------
* Less than 1% of total.
(1) In accordance with the Commission's rules, each beneficial owner's holdings
have been calculated assuming the full exercise of options and the
conversion of all shares of convertible preferred stock held by the holder
which are currently exercisable or convertible or which will become
exercisable or convertible within 60 days after the date indicated and no
exercise of options or conversion of preferred stock held by any other
person.
(2) Includes 4,166,667 shares of Series B Convertible Preferred Stock
(purchased in May 1999) which are convertible into common stock on a
one-for-one basis. The address of this beneficial owner is 901 Fleet
Center, 50 Kennedy Plaza, Providence, Rhode Island 02903.
(3) Includes options to purchase 36,000 shares of common stock which are
presently exercisable and 3,170,878 shares of common stock owned by the
various partnerships, trusts or corporations with respect to which Mr.
Gallagher is a general partner, beneficiary and/or controlling stockholder.
Also includes 44,730 shares owned by a trust for the benefit of Mr.
Gallagher's minor children with respect to which Mr. Gallagher disclaims
any beneficial ownership interest. Mr. Gallagher's address is 3301 N.
Buffalo Drive, Las Vegas, Nevada 89129.
(4) Includes 1,139,571 shares of common stock and 555,556 shares of Series B
Convertible Preferred Stock (purchased in May 1999) owned by partnerships
in which Mr. Kronfeld is a general partner or manager of a general partner.
The shares of Series B Convertible Preferred Stock are convertible into
common stock on a one-for-one basis. Mr. Kronfeld's address is JK&B
Management, L.L.C., 205 North Michigan, Suite 808, Chicago, Illinois 60601.
(5) Includes 555,556 shares of Series B Convertible Preferred Stock (purchased
in May 1999) which are convertible into common stock on a one-for-one
basis. The address of this beneficial holder is One Towne Square, Suite
780, Southfield, Michigan 48076.
(6) The address of this beneficial holder is 300 Drakes Landing Road, Suite
290, Greenbrae, California 94904.
(7) Includes options to purchase 216,000 shares which are presently
exercisable. Mr. Montgomery's address is 3301 N. Buffalo Drive, Las Vegas,
Nevada 89129.
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(8) Includes options to purchase 7,200 shares which are presently exercisable
or will become exercisable within 60 days after the date of this prospectus
and 102,000 shares of common stock owned by various partnerships or
corporations with respect to which Mr. Flynn is a general partner and/or
controlling stockholder. Mr. Flynn's address is 3291 N. Buffalo Drive,
Suite 8, Las Vegas, Nevada 89129.
(9) Includes 685,714 shares of common stock held for the account of entities
associated with Chatterjee Management Company. Mr. Neustaetter is an
officer of Chatterjee Management Company. Mr. Neustaetter disclaims
beneficial ownership of these shares as he does not exercise investment or
voting power over them.
(10) Includes options to purchase 7,200 shares that are presently exercisable or
will become exercisable within 60 days after the date of this prospectus.
(11) Excludes 4,166,667 shares of Series B Convertible Preferred Stock owned by
Providence Equity Partners III L.P. and its affiliates. Mr. Salem disclaims
beneficial ownership of these shares except to the extent of his pecuniary
interest in the general partner of Providence Equity Partners III L.P.
(12) Includes options to purchase 131,400 shares owned by executive officers not
named above which are presently exercisable.
SELLING STOCKHOLDERS
The selling stockholders listed in the table below have agreed to sell the
number of shares of common stock indicated opposite their respective names. The
table sets forth information about common stock held of record by the selling
stockholders as of the date of this prospectus and as adjusted to reflect the
sale of shares of common stock in this offering. Information with respect to
ownership has been furnished by the respective selling stockholders. There is
and has been no material relationship during our history between us or any
affiliate of ours and any selling stockholder except as described in the
footnotes appearing at the end of the following table.
<TABLE>
<CAPTION>
SHARES OWNED SHARES SHARES OWNED
BEFORE THIS SOLD IN THIS AFTER THIS
SELLING STOCKHOLDER OFFERING OFFERING OFFERING
- ------------------- ------------ ------------ --------------
<S> <C> <C> <C>
Strategic Investment Partners Limited(1)..... 342,857 342,857 --
S-C Phoenix Holdings LLC(1).................. 214,285 171,428 42,857
Winston Partners II LDC(1)................... 85,714 33,436 52,278
Winston Partners II LLC(1)................... 42,857 10,627 32,230
Prospect Street High Income Portfolio,
Inc.(2) ................................... 15,870 15,870 --
CPR (USA) Inc................................ 8,357 8,357 --
Libertyview Funds LP......................... 2,695 2,695 --
Libertyview Enhanced High Yield Fund......... 2,425 2,425 --
</TABLE>
- -------------------------
(1) This selling stockholder is associated with Chatterjee Management Company.
Mr. Neustaetter, a member of our Board of Directors, is an officer of
Chatterjee Management Company.
(2) This selling stockholder currently owns warrants to purchase the number of
shares indicated.
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<PAGE> 53
DESCRIPTION OF SECURITIES
GENERAL -- CAPITAL STOCK
The following description is a summary of the material terms of our capital
stock. It is not a complete description of all of the terms of our capital
stock. You should read this description of our capital stock as well as the
Nevada General Corporation Law, our Articles of Incorporation, including the
Certificate of Designation of the Series B Convertible Preferred Stock, and our
By-laws. Copies of our Articles and By-laws have been filed as exhibits to the
registration statement of which this prospectus is a part.
Our authorized capital stock consists of 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. As of July 20, 1999, 17,685,434 shares of common stock and
5,277,779 shares of Series B Convertible Preferred Stock (the "Series B
Preferred Stock") were outstanding and 2,621,371 shares of common stock were
subject to outstanding options and warrants. As of June 30, 1999, there were
approximately 170 holders of record of the common stock and five holders of
record of the Series B Preferred Stock.
If we issue preferred stock in the future, the preferred stock will have
the rights, terms and preferences specified by our Board of Directors in a
certificate filed with the Secretary of State of Nevada. As of the date of this
prospectus, we have authorized the issuance of up to 5,278,000 shares of Series
B Preferred Stock with the voting, dividend, liquidation and conversion rights
described below. The issuance of preferred stock by the Board of Directors in
the future could adversely affect the rights of holders of common stock. For
example, an issuance of preferred stock could result in a class of securities
outstanding with preferences over the common stock with respect to dividends and
liquidations and/or a class of securities with voting rights equal to or greater
than those of the common stock. We have no present plan to issue any additional
series of preferred stock. See "-- Anti-Takeover Provisions of Articles of
Incorporation."
SERIES B CONVERTIBLE PREFERRED STOCK
The Series B Preferred Stock has the following rights and preferences:
Dividends accrue at the rate of 10% per year, are cumulative and must be
paid before any dividends may be paid on our common stock. Beginning November
22, 1999, we may elect to terminate the accrual of dividends if our common stock
price per share exceeds $27.00 for 20 consecutive trading days. Except as
described below, accrued dividends will be paid in common stock at the time the
Series B Preferred Stock is converted into common stock if the dividends have
not been paid prior to that time.
On any matter submitted to our stockholders, holders of shares of Series B
Preferred Stock will be treated as if they hold the number of shares of common
stock into which their shares of Series B Preferred Stock could be converted and
will be allowed to vote those shares along with the holders of our common stock.
In addition, the holders of shares of Series B Preferred Stock will have the
right to approve any action to:
- issue preferred stock ranking equal or senior to the Series B Preferred
Stock;
- dispose of assets in excess of a fixed dollar amount, merge or
consolidate or sell our company;
- liquidate our company;
- alter the terms of the Series B Preferred Stock;
- pay dividends on common stock or other securities junior to the Series B
Preferred Stock;
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<PAGE> 54
- enter into transactions with our affiliates other than transactions
covered by specified exceptions;
- make acquisitions in excess of a fixed dollar amount;
- incur additional debt in excess of fixed amounts;
- make material changes to our business plan;
- hire a chief executive officer;
- organize subsidiaries or enter into joint ventures unless specified
conditions are met; and
- issue additional common stock that would result in an increase in the
number of shares of common stock into which the Series B Preferred Stock
may be converted.
If we were to take one of these restricted actions without the approval of
the holders of the Series B Preferred Stock, the holders of the Series B
Preferred Stock may have the right to require us to seek a sale of our company.
To avoid having to sell our company in the event one of the restricted actions
described above is not approved, we have the right to redeem the Series B
Preferred Stock at predetermined prices. If we elect not to redeem the Series B
Preferred Stock and such a sale is not effected within six months, then the
holders of the Series B Preferred Stock would be entitled to elect a majority of
our Board of Directors.
The approval rights described above will terminate if fewer than 1,759,260
shares of Series B Preferred Stock remain outstanding and the shares of Series B
Preferred Stock outstanding constitute less than 5% of the outstanding common
stock assuming conversion of all outstanding shares of Series B Preferred Stock.
Based on the number of shares of common stock to be outstanding after this
offering, 5% of the common stock would be approximately 1,398,000 shares.
The holders of the Series B Preferred Stock have the right to nominate one
or more directors depending on the size of our Board of Directors and the
percentage of our stock represented by the outstanding Series B Preferred Stock.
The holders of the Series B Preferred Stock also have the right to have their
Board representative serve on each committee of our Board and on the board of
each of our subsidiaries. The holders of the Series B Preferred Stock are
currently entitled to nominate one director since we have seven directors. Paul
J. Salem has been elected to the Board after being nominated by the holders of
Series B Preferred Stock.
The right to nominate directors will terminate if fewer than 1,759,260
shares of Series B Preferred Stock remain outstanding and the shares of Series B
Preferred Stock outstanding constitute less than 5% of the outstanding common
stock assuming conversion of all outstanding shares of Series B Preferred Stock.
Upon our liquidation, the holders of the Series B Preferred Stock are
entitled to receive their liquidation amount before any amounts may be paid to
holders of our common stock or other junior securities. The liquidation amount
will be the greater of (a) $9.00 per share plus accrued and unpaid dividends or
(b) the amount the holders of Series B Preferred Stock would have received if
the Series B Preferred Stock had been converted into common stock. The holders
of the Series B Preferred Stock have the right to elect that a sale of our
company be treated as a liquidation for these purposes. If the liquidation or
sale occurs before May 4, 2002, the accrued dividends will not be paid to the
extent the holders of Series B Preferred Stock will receive more than $22.50 per
share.
A holder of shares of Series B Preferred Stock may convert those shares
into common stock at any time. Initially, each share of Series B Preferred Stock
may be converted into one share of common stock. The number of shares of common
stock into which each share of Series B Preferred Stock can be converted may be
adjusted as a result of stock splits, stock dividends and other issuances of
additional stock.
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<PAGE> 55
After the earlier of May 24, 2000 or the date on which the holders of
Series B Preferred Stock exercise their demand registration rights, which are
discussed below, we have the right to require the conversion of the Series B
Preferred Stock if our common stock price exceeds $27.00 per share for 20
consecutive trading days. If we require conversion before May 4, 2002, no
accrued dividends will be paid.
The holders of Series B Preferred Stock have the right to require us to
redeem the Series B Preferred Stock after May 4, 2005 or upon a sale of our
company. The redemption price will be equal to the greater of:
- $9.00 per share plus accrued and unpaid dividends; or
- the value of the common stock into which the Series B Preferred Stock is
then convertible.
If we fail to redeem all shares of Series B Preferred Stock within six
months of the date specified by the holders of the Series B Preferred Stock,
then the holders of the Series B Preferred Stock will have the right to elect a
majority of our Board of Directors.
The holders of Series B Preferred Stock have demand and piggyback
registration rights, although a demand registration may not be initiated by the
holders of the Series B Preferred Stock before May 4, 2000, unless our stock
price exceeds $27.00 per share for 20 consecutive trading days.
OUTSTANDING WARRANTS
As of July 20, 1999, there are outstanding warrants ("Warrants") to
purchase approximately 509,721 shares of common stock. These warrants were
originally issued in September 1997 to purchasers of units consisting of our
Senior Secured Notes and the Warrants. Each holder of a Warrant may purchase
shares of common stock at a price of $.02 per share at any time on or before
October 1, 2004.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, we will have outstanding 22,701,304
shares of common stock, including up to 15,870 shares to be sold in this
offering by selling stockholders now owning warrants. Of these shares, the
estimated 5,587,695 shares to be sold in this offering, any additional shares
sold upon exercise of the over-allotment option granted to the underwriters, the
4,025,000 shares sold in our initial public offering and approximately 151,000
shares issued upon exercise of stock options will be freely tradable without
restriction or further registration under the Securities Act unless those shares
are held by our "affiliates" as defined by the Securities Act.
The remaining 12,937,609 shares of our common stock, plus 5,277,779 shares
of common stock which may be issued upon conversion of the Series B Preferred
Stock, are "restricted securities" under the Securities Act because they were
issued and sold by us in private transactions in reliance upon exemptions from
registration under the Securities Act. Restricted securities may not be sold
except in compliance with the registration requirements of the Securities Act or
under an exemption from registration, such as the exemption provided by Rule 144
under the Securities Act. Substantially all of these restricted securities,
other than the 5,277,779 shares of common stock which may be issued upon
conversion of the Series B Preferred Stock, currently qualify for sale under
Rule 144.
The holders of approximately 9,104,891 shares of our common stock,
5,277,779 shares of the Series B Preferred Stock and Warrants to purchase
509,721 shares of common stock (other than holders including shares in this
offering) have agreed not to offer, sell or otherwise dispose of their
securities in the public market until at least 90 days after the offering is
completed without the consent of Bear, Stearns & Co. Inc. After the 90 day
period, all of these securities other than the
55
<PAGE> 56
5,277,779 shares of the Series B Preferred Stock will be eligible for sale in
the public market upon registration or compliance with Rule 144 under the
Securities Act.
Sales of a substantial amount of common stock in the public market, or the
perception that sales could occur, could reduce the price of our stock.
REGISTRATION RIGHTS OF SECURITY HOLDERS
The holders of the 5,277,779 shares of our outstanding Series B Preferred
Stock, the holders of 807,899 shares of common stock that have been or may be
acquired upon exercise of the Warrants and the holders of 3,102,747 shares of
common stock received upon conversion of the Series A Convertible Preferred
Stock upon our initial public offering have the right to demand that their
common stock be registered with the SEC. The demand rights of the holders of the
Series B Preferred Stock may not be exercised before May 4, 2000, unless our
stock price exceeds $27.00 per share for 20 consecutive trading days and may not
in any event be exercised before August 2, 1999.
The holders of the 5,277,779 shares of our outstanding Series B Preferred
Stock, the holders of 807,899 shares of common stock that have been or may be
acquired upon exercise of the Warrants and the holders of an additional
3,129,748 shares of common stock have piggyback registration rights under
agreements with us.
FUTURE SALE OF STOCK TO EMPLOYEES
We plan to seek to attract and retain employees in part by offering stock
options and other purchase rights for a significant number of our shares of
common stock. These plans may dilute the percentage of ownership of our then
existing stockholders.
CONTROL SHARE ACQUISITIONS
Sections 78.3791 through 78.3793 of the Nevada Revised Statutes generally
apply to any acquisition of outstanding voting securities of an Issuing
Corporation which results in the acquiror owning more than 20% of the Issuing
Corporation's then outstanding voting securities. An Issuing Corporation is any
Nevada corporation with at least 200 stockholders, at least 100 of which are
stockholders of record and Nevada residents, and which conducts business in
Nevada.
The securities acquired in a covered acquisition are denied voting rights
unless a majority of the security holders of the Issuing Corporation approve the
granting of voting rights. If permitted by the Issuing Corporation's Articles of
Incorporation or By-laws then in effect, voting securities acquired in the
covered acquisition are redeemable by the Issuing Corporation at the average
price paid for the securities by the acquiror if the acquiring person has not
given timely notice to the Issuing Corporation or if the stockholders of the
Issuing Corporation vote not to grant voting rights to the acquiring person's
securities.
Unless the Issuing Corporation's Articles of Incorporation or By-laws then
in effect provide otherwise, if the acquiring person acquired securities having
50% or more of the voting power of the Issuing Corporation's outstanding
securities and the stockholders of the Issuing Corporation grant voting rights
to the acquiring person, then any stockholders of the Issuing Corporation who
voted against granting voting rights to the acquiring person may demand that the
Issuing Corporation purchase, for fair value, all or any portion of his
securities.
Our Articles of Incorporation and By-laws do not limit the effect of these
provisions.
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<PAGE> 57
TRANSFER AGENT
The Transfer Agent and Registrar for our common stock is Continental Stock
Transfer & Trust Company, New York, New York.
LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS
The right of the stockholders to sue any director for misconduct in
conducting our affairs is limited by our Articles of Incorporation and Nevada
statutes to cases for damages resulting from breaches of fiduciary duties
involving acts or omissions involving intentional misconduct, fraud, knowing
violations of the law or the unlawful payment of dividends. Ordinary negligence
is not grounds for suit. The statute does not limit the liability of directors
or officers for monetary damages under the federal securities laws.
We also have the obligation, under our By-laws, to indemnify any director
or officer of ours for all expenses incurred by them in connection with any
legal action brought or threatened against the person for or on account of any
action or omission alleged to have been committed while acting in the course and
scope of the person's duties, if the person acted in good faith and in a manner
which the person reasonably believed to be in or not opposed to our best
interests, and with respect to criminal actions, had no reasonable cause to
believe the person's conduct was unlawful, provided that indemnification is made
under then existing provisions of Nevada General Corporation Law at the time of
indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to our directors, officers or other controlling persons under
the foregoing provisions, we have been informed that in the opinion of the SEC
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.
ANTI-TAKEOVER PROVISIONS OF ARTICLES OF INCORPORATION
Our Articles of Incorporation authorize our Board of Directors to issue up
to 50,000,000 shares of preferred stock from time to time in one or more
designated series or classes. As of May 12, 1999, 5,278,000 shares of preferred
stock have been designated as Series B Preferred Stock and 5,277,779 shares of
Series B Preferred Stock were outstanding. We previously issued 6,571,427 shares
of Series A Convertible Preferred Stock which reverted to authorized but
unissued shares of preferred stock when we closed our initial public offering of
common stock. Our Board of Directors, without approval of the stockholders, is
authorized to establish the voting, dividend, redemption, conversion,
liquidation and other provisions of a particular series of preferred stock,
which could, among other things, adversely affect the voting power or other
rights of the holders of common stock and, under some circumstances, make it
more difficult for a third party to acquire, or discourage a third party from
acquiring, control of our company. Our Board of Directors has no present
intention to authorize the issuance of any additional series of preferred stock.
BOARD OF DIRECTORS
Our By-laws provide that our Board is divided into three classes of
directors, with each class having a number of directors as nearly equal as
possible and with the term of each class expiring in a different year. Because
only one class of directors stands for election or re-election each year,
classifying our Board prevents persons seeking to acquire control of our company
from electing more than a minority of directors in any year, thereby delaying,
deferring or preventing a change in control. Our By-laws provide that our Board
shall consist of between three and nine members, with the exact number to be
determined from time to time by our Board. Our Board has set the number of
directors at seven and, as a result, the size of each class is two or three.
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<PAGE> 58
STOCKHOLDER ACTION AND SPECIAL MEETINGS
Our By-laws provide that:
- all action required or permitted to be taken by our stockholders must be
effected at a duly called annual or special meeting of stockholders and
may not be effected by any consent in writing, and
- the number of directors is set by resolution of our Board.
These provisions may have the effect of deterring hostile takeovers or delaying
changes in control or management of our company. Our By-laws provide that
special meetings of stockholders may be called by the Board, the Chairman of the
Board, the President or the holders of at least a majority of the shares of our
common stock issued and outstanding and entitled to vote.
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<PAGE> 59
UNDERWRITING
The underwriters of this offering named below have severally agreed with us
under the terms and conditions of the underwriting agreement (the form of which
has been filed as an exhibit to the registration statement on Form S-3 of which
this prospectus is a part), to purchase from us and the selling stockholders the
aggregate number of shares of common stock set forth opposite their respective
names below:
<TABLE>
<CAPTION>
THE UNDERWRITERS NUMBER OF SHARES
- ---------------- ----------------
<S> <C>
Bear, Stearns & Co. Inc.....................................
Goldman, Sachs & Co. .......................................
ING Barings LLC.............................................
-----------
Total.....................................................
===========
</TABLE>
The obligations of the underwriters to purchase the shares from us and the
selling stockholders under the underwriting agreement are conditioned upon
approval of legal matters by counsel and other conditions. The underwriters are
committed to purchase and pay for all of the above shares, if any of the shares
are purchased.
If the underwriters sell more than the total number of shares set forth in
the table above, the underwriters have an option to buy up to an additional
838,154 shares from us to cover such sales. They may exercise this option for 30
days. If any shares are purchased pursuant to this option, the underwriters will
severally purchase shares in approximately the same proportion as set forth in
the table above.
Shares sold by the underwriters to the public will initially be offered at
the per share offering price on the cover page of this prospectus, less an
amount not greater than the per share amount of the concession to dealers
described below. Any shares sold by the underwriters to securities dealers may
be sold at a discount of up to $ per share from the public offering price.
Securities dealers may resell any shares purchased from the underwriters to
other brokers or dealers at a discount of up to $ per share from the public
offering price. If all the shares are not sold at the public offering price, the
representatives may change the public offering price and the other selling
terms.
The following table shows the per share and total underwriting discounts
and commissions to be paid to the underwriters by us and by the selling
stockholders. With respect to the underwriting discounts and commissions to be
paid by us, these amounts are shown assuming both no exercise and full exercise
of the underwriters' option to purchase additional shares.
<TABLE>
<CAPTION>
PAID BY US
----------------------- PAID BY
NO EXERCISE EXERCISE SELLING STOCKHOLDERS
----------- -------- --------------------
<S> <C> <C> <C>
Per share...................................... $ $ $
Total.......................................... $ $ $
</TABLE>
We estimate that our share of the total expenses of this offering,
excluding underwriting discounts and commissions, will be approximately
$650,000.
Under the underwriting agreement, we and the selling stockholders have
agreed to indemnify the underwriters against certain liabilities under the
Securities Act or to contribute to payments the underwriters are required to
make as a result of certain liabilities under the Securities Act.
The holders of approximately 9,104,891 shares of our common stock,
5,277,779 shares of the Series B Preferred Stock and Warrants to purchase
509,721 shares of common stock (other than holders including shares in this
offering) have agreed not to offer, sell or otherwise dispose of their
59
<PAGE> 60
securities in the public market until at least 90 days after the offering is
completed without the consent of Bear, Stearns & Co. Inc. After the 90 day
period, all of these securities other than the 5,277,779 shares of the Series B
Preferred Stock will be eligible for sale in the public market upon registration
or compliance with Rule 144 under the Securities Act.
In addition, we have agreed that for a period of 120 days after the date of
this prospectus we will not, without the written consent of Bear, Stearns & Co.
Inc., offer, sell or dispose of any shares of our common stock except for the
shares offered by this prospectus, shares which may be issued upon exercise of
outstanding warrants and shares issued and options granted under our existing
stock option plan or to newly hired management level employees.
In connection with this offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in this offering.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or slowing a decline in the market price of the common
stock while this offering is in progress.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such underwriter in stabilizing or short covering
transactions. These activities by the underwriters may stabilize, maintain or
otherwise affect the market price of the common stock. As a result, the price of
the common stock may be higher than the price that otherwise might exist in the
open market. A penalty bid may also affect the price of the common stock if it
discourages resales of the common stock. No assurance is made as to the
magnitude or effect of any stabilization or other transactions. If these
activities are commenced, they may be discontinued by the underwriters at any
time. These transactions may be effected on the Nasdaq National Market, in the
over-the-counter market or otherwise.
In connection with this offering, certain underwriters and selling group
members, if any, who are qualified market makers on the Nasdaq National Market
may engage in passive market making transactions in the common stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Exchange Act. Passive market makers must comply with applicable volume and price
limitations and must be identified as passive market makers. In general, a
passive market maker must display its bid at a price not in excess of the
highest independent bid for the security; if all independent bids are lowered
below the passive market maker's bid, however, the bid must then be lowered when
certain purchase limits are exceeded.
Bear, Stearns & Co. Inc. and Furman Selz LLC, a predecessor in interest to
ING Barings LLC, acted as initial purchasers in connection with the offering in
September 1997 of units consisting of Senior Secured Notes and Warrants. Bear,
Stearns & Co. Inc. and Furman Selz LLC also acted as placement agents in
connection with the sale of Series A Convertible Preferred Stock in November
1997 (the "November 1997 Private Placement"), for which they received customary
fees. During January 1998, we sold additional shares of Series A Convertible
Preferred Stock (the "January 1998 Private Placement") for which neither Bear,
Stearns & Co. Inc. nor Furman Selz LLC received any commission. Bear, Stearns &
Co. Inc. and Furman Selz LLC acted as representatives of the underwriters (which
included Goldman Sachs & Co.) in our initial public offering of our common
stock, for which they received customary fees. In addition, an affiliate of ING
Barings LLC provides cash management services to us for which it receives
customary fees.
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<PAGE> 61
LEGAL MATTERS
Certain legal matters regarding the validity of the common stock offered by
this prospectus will be passed upon for us by Ellis, Funk, Goldberg, Labovitz &
Dokson, P.C., Atlanta, Georgia. Shareholders of Ellis, Funk, Goldberg, Labovitz
& Dokson, P.C. own approximately 21,600 shares of our common stock. Kronish Lieb
Weiner & Hellman LLP, New York, New York, is acting as counsel to the
underwriters in connection with certain legal matters relative to the common
stock offered by this prospectus.
EXPERTS
The financial statements included in this prospectus and elsewhere in the
registration statement, to the extent and for the periods indicated in their
reports, have been audited by Arthur Andersen LLP and KPMG LLP, independent
public accountants, and are included herein in reliance upon the authority of
these firms as experts in giving said reports.
WHERE YOU CAN FIND MORE INFORMATION
We must comply with the periodic reporting and other informational
requirements of the Exchange Act and file reports, proxy statements and other
information with the SEC. Copies of our periodic reports and proxy statements
and of other information filed by us with the SEC may be inspected at the public
reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549, or at its regional offices located at the Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World
Trade Center, 13th Floor, New York, New York 10007. The SEC maintains an
Internet site that contains reports, proxy and information statements and other
information regarding us. The address of the SEC's Web site is
http://www.sec.gov. Our Internet address is http://www.mgci.com.
We have filed with the SEC a registration statement on Form S-3 under the
Securities Act covering the common stock being offered. This prospectus does not
contain all the information included in the registration statement, parts of
which are omitted as allowed by the rules of the SEC. For further information
about us and the securities offered, please refer to the registration statement.
The registration statement may be inspected and copied, at prescribed rates, at
the SEC's public reference facilities at the addresses shown above. Statements
made in this prospectus concerning the contents of any document referred to in
this prospectus are not necessarily complete. With respect to each document
filed with the SEC as an exhibit to the registration statement, you should refer
to the exhibit for a more complete description of the matter involved.
The following documents filed by us with the SEC are incorporated into this
prospectus by reference:
- our Annual Report on Form 10-K for the fiscal year ended December 31,
1998;
- our Quarterly Report on Form 10-Q for the quarter ended March 31, 1999;
- the description of our common stock included in our registration
statement filed under the Exchange Act and any amendment or report filed
for the purpose of updating that description; and
- all reports filed by us to comply with Section 13(a) or 15(d) of the
Exchange Act since the end of the quarter covered by our Quarterly Report
on Form 10-Q for our quarter ended March 31, 1999.
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<PAGE> 62
All documents filed by us as required by Section 13(a), 13(c), 14, or 15(d) of
the Exchange Act after the date of this prospectus are incorporated by reference
in this prospectus and are made a part of this prospectus from the date of
filing of these documents.
Any statement contained in a document incorporated by reference in this
prospectus shall be deemed to be modified or superseded for purposes of this
prospectus to the extent that a statement contained in this prospectus or in any
other subsequently filed document which also is incorporated by reference
modifies or supersedes an earlier statement. Any earlier statement so modified
or superseded shall not be deemed, except as so modified or superseded, to
constitute a part of this prospectus.
THIS PROSPECTUS INCORPORATES DOCUMENTS BY REFERENCE WHICH ARE NOT PRESENTED
IN OR DELIVERED WITH THIS PROSPECTUS. THESE DOCUMENTS ARE AVAILABLE TO YOU
WITHOUT CHARGE UPON YOUR WRITTEN OR ORAL REQUEST. TO REQUEST THESE DOCUMENTS,
PLEASE CONTACT KENT F. HEYMAN, ESQ., VICE PRESIDENT AND GENERAL COUNSEL, MGC
COMMUNICATIONS, INC., 3301 N. BUFFALO DRIVE, LAS VEGAS, NEVADA 89129 (TELEPHONE
702-310-8258).
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<PAGE> 63
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
MGC COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Independent Auditors' Report................................ F-3
Consolidated Balance Sheets as of March 31, 1999 (unaudited)
and December 31, 1998 and 1997............................ F-4
Consolidated Statements of Operations for the three months
ended March 31, 1999 and 1998 (unaudited) and for the
years ended December 31, 1998, 1997 and 1996.............. F-5
Consolidated Statements of Redeemable Preferred Stock and
Stockholders' Equity for the three months ended March 31,
1999 (unaudited) and for the years ended December 31,
1998, 1997 and 1996....................................... F-6
Consolidated Statements of Cash Flows for the three months
ended March 31, 1999 and 1998 (unaudited) and for the
years ended December 31, 1998, 1997 and 1996.............. F-7
Notes to Consolidated Financial Statements.................. F-8
</TABLE>
F-1
<PAGE> 64
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and
Board of Directors of
MGC Communications, Inc.:
We have audited the accompanying consolidated balance sheets of MGC
Communications, Inc. (a Nevada corporation) and subsidiary (the "Company") as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, redeemable preferred stock and stockholders' equity and cash flows
for the years then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of MGC Communications, Inc. and
subsidiary as of December 31, 1998 and 1997, and the results of their operations
and their cash flows for the years then ended in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
March 2, 1999
F-2
<PAGE> 65
INDEPENDENT AUDITORS' REPORT
The Board of Directors
MGC Communications, Inc.
We have audited the accompanying statements of operations, stockholders'
equity and cash flows of MGC Communications, Inc. for the year ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations and the cash flows of MGC
Communications, Inc. for the year ended December 31, 1996, in conformity with
generally accepted accounting principles.
/s/ KPMG LLP
Las Vegas, Nevada
August 18, 1997
F-3
<PAGE> 66
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, --------------------
1999 1998 1997
----------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 5,972 $ 11,886 $ 45,054
Investments held-to-maturity.............................. -- -- 7,797
Investments available-for-sale............................ 1,867 9,851 --
Restricted investments.................................... 31,428 20,797 18,482
Accounts receivable, less allowance for doubtful accounts
of $363, $257 and $216.................................. 8,988 6,360 1,200
Prepaid expenses.......................................... 250 208 277
-------- -------- --------
Total current assets............................... 48,505 49,102 72,810
Property and equipment, net................................. 128,136 116,380 24,617
Investments held-to-maturity................................ -- -- 49,913
Investments available-for-sale.............................. 47,468 63,212 --
Restricted investments...................................... 8,501 18,582 39,092
Deferred financing costs, net of accumulated amortization of
$1,272, $1,065 and $198................................... 4,507 4,714 5,448
Other assets................................................ 436 129 97
-------- -------- --------
Total assets....................................... $237,553 $252,119 $191,977
======== ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt........................ $ 241 $ 332 $ 381
Accounts payable:
Trade..................................................... 12,133 5,314 462
Property and equipment.................................... 5,683 18,577 3,123
Accrued interest............................................ 10,400 5,200 5,328
Accrued other expenses...................................... 3,402 2,473 786
-------- -------- --------
Total current liabilities.......................... 31,859 31,896 10,080
Senior Secured Notes, net of unamortized discount of $3,163,
$3,307 and $3,882......................................... 156,837 156,693 156,118
Other long-term debt........................................ 208 270 138
-------- -------- --------
Total liabilities.................................. 188,904 188,859 166,336
-------- -------- --------
Commitments and contingencies
Redeemable preferred stock:
8% Series A Convertible Preferred Stock, 6,571,450 shares
authorized, 5,148,570 issued and outstanding at December
31, 1997................................................ -- -- 16,665
Stockholders' equity:
Preferred stock, 43,428,550 shares authorized but
unissued................................................ -- -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 17,236,134, 17,190,428 and 8,799,600 shares
issued and outstanding.................................. 17 17 9
Additional paid-in capital................................ 109,231 108,991 22,118
Accumulated deficit....................................... (58,604) (44,392) (12,463)
-------- -------- --------
50,644 64,616 9,664
Accumulated other comprehensive income.................... 178 817 --
Notes receivable from stockholders for issuance of common
stock................................................... (2,173) (2,173) (688)
-------- -------- --------
Total stockholders' equity......................... 48,649 63,260 8,976
-------- -------- --------
Total liabilities, redeemable preferred stock and
stockholders' equity............................. $237,553 $252,119 $191,977
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 67
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31, DECEMBER 31,
---------------------- --------------------------------
1999 1998 1998 1997 1996
---------- --------- ---------- --------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating revenues:
Telecommunication services..... $ 8,401 $ 2,846 $ 18,249 $ 3,791 $ 1
---------- --------- ---------- --------- -------
Operating expenses:
Cost of operating revenues..... 8,483 2,371 17,129 3,928 305
Selling, general and
administrative.............. 7,727 2,562 17,877 6,440 841
Depreciation and
amortization................ 3,484 867 5,238 1,274 54
Write-off of purchased
software.................... -- -- -- -- 355
---------- --------- ---------- --------- -------
19,694 5,800 40,244 11,642 1,555
---------- --------- ---------- --------- -------
Loss from operations........ (11,293) (2,954) (21,995) (7,851) (1,554)
Other income (expense):
Gain on sale of investments.... 205 -- 223 -- --
Interest income................ 1,500 2,169 8,771 2,507 63
Interest expense............... (4,624) (5,505) (19,064) (5,492) --
---------- --------- ---------- --------- -------
Net loss.................... (14,212) (6,290) (32,065) (10,836) (1,491)
Accrued preferred stock
dividend....................... -- (444) -- (136) --
Net loss applicable to common
stockholders................... $ (14,212) $ (6,734) $ (32,065) $ (10,972) $(1,491)
========== ========= ========== ========= =======
Basic and diluted loss per share
of common stock................ $ (.83) $ (.76) $ (2.26) $ (1.30) $ (2.11)
========== ========= ========== ========= =======
Basic and diluted weighted
average shares outstanding..... 17,204,944 8,892,282 14,178,729 8,458,991 707,359
========== ========= ========== ========= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 68
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
NOTES
REDEEMABLE RECEIVABLE FROM
PREFERRED STOCK COMMON STOCK ADDITIONAL STOCKHOLDERS FOR
--------------------- ------------------- PAID-IN ACCUMULATED ISSUANCE OF
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT COMMON STOCK
---------- -------- ---------- ------ ---------- ----------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996......... -- $ -- 240,000 $-- $ 1 $ -- $ --
Common stock issued for services
contributed by stockholder....... -- -- 480,000 1 1 -- --
Common stock issued for cash....... -- -- 6,456,000 6 12,274 -- --
Net loss........................... -- -- -- -- -- (1,491) --
---------- -------- ---------- --- -------- -------- -------
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 -- (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) (688)
Common stock issued for cash....... -- -- 100,680 -- 774 -- --
Common stock issued for notes
receivable....................... -- -- 189,000 -- 1,485 -- (1,485)
Warrants and options exercised for
common stock..................... -- -- 133,309 -- 14 -- --
8% Series A Convertible Preferred
Stock issued for cash............ 1,422,857 4,980 -- -- -- -- --
Accrued preferred stock dividend... -- -- -- -- -- (654) --
Common stock issued for cash....... -- -- 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 --
Unrealized gain on investments
available-for-sale............... -- -- -- -- -- -- --
Net loss........................... -- -- -- -- -- (32,065) --
---------- -------- ---------- --- -------- -------- -------
BALANCE AT DECEMBER 31, 1998....... -- -- 17,190,428 17 108,991 (44,392) (2,173)
Unrealized loss on investments
available-for-sale............... -- -- -- -- -- -- --
Common stock issued................ -- -- 45,706 -- 240 -- --
Net loss........................... -- -- -- -- -- (14,212) --
---------- -------- ---------- --- -------- -------- -------
BALANCE AT MARCH 31, 1999
(unaudited)...................... -- $ -- 17,236,134 $17 $109,231 $(58,604) $(2,173)
========== ======== ========== === ======== ======== =======
<CAPTION>
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE STOCKHOLDERS'
INCOME EQUITY
------------- --------------
<S> <C> <C>
BALANCE AT JANUARY 1, 1996......... $ -- $ 1
Common stock issued for services
contributed by stockholder....... -- 2
Common stock issued for cash....... -- 12,280
Net loss........................... -- (1,491)
---- --------
BALANCE AT DECEMBER 31, 1996....... -- 10,792
Common stock issued for cash....... -- 4,862
Common stock issued for notes
receivable....................... -- --
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....... -- 8,976
Common stock issued for cash....... -- 774
Common stock issued for notes
receivable....................... -- --
Warrants and options exercised for
common stock..................... -- 14
8% Series A Convertible Preferred
Stock issued for cash............ -- --
Accrued preferred stock dividend... -- (654)
Common stock issued for cash....... -- 62,963
Conversion of preferred stock to
common stock..................... -- 22,435
Unrealized gain on investments
available-for-sale............... 817 817
Net loss........................... -- (32,065)
---- --------
BALANCE AT DECEMBER 31, 1998....... 817 63,260
Unrealized loss on investments
available-for-sale............... (639) (639)
Common stock issued................ -- 240
Net loss........................... -- (14,212)
---- --------
BALANCE AT MARCH 31, 1999
(unaudited)...................... $178 $ 48,649
==== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 69
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS YEAR ENDED
ENDED MARCH 31, DECEMBER 31,
-------------------- ---------------------------------
1999 1998 1998 1997 1996
-------- -------- -------- --------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss................................... $(14,212) $ (6,290) $(32,065) $ (10,836) $ (1,491)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization............ 3,484 867 5,238 1,274 54
Write-off of purchased software.......... -- -- -- -- 355
Gain on sale of investments.............. (205) -- (223) -- --
Amortization of debt discount............ 144 144 575 144 --
Amortization of deferred financing
costs.................................. 207 210 867 198 --
Stock issued for services rendered....... -- -- -- -- 2
Changes in assets and liabilities:
Increase in accounts receivable, net..... (2,628) (1,442) (5,160) (1,190) (9)
(Increase) decrease in prepaid
expenses............................... (42) (46) 69 (254) (23)
Increase in other assets................. (307) (52) (32) (91) (5)
Increase in accounts payable -- trade.... 6,819 1,446 4,852 386 76
Increase in accrued interest and other
expenses............................... 6,129 4,981 1,695 5,879 99
-------- -------- -------- --------- --------
Net cash used in operating
activities.......................... (611) (182) (24,184) (4,490) (942)
-------- -------- -------- --------- --------
Cash flows from investing activities:
Purchase of property and equipment, net of
payables................................. (15,240) (9,795) (81,597) (20,207) (2,287)
Decrease in accounts payable-property
and equipment............................ (12,894) -- -- -- --
Purchase of investments held-to-maturity... -- (276) -- (57,710) --
Sale (purchase) of investments
available-for-sale, net.................. 23,294 -- (14,313) -- --
(Purchase) sale of restricted
investments.............................. (550) (792) 18,195 (57,574) --
-------- -------- -------- --------- --------
Net cash used in investing
activities.......................... (5,390) (10,863) (77,715) (135,491) (2,287)
-------- -------- -------- --------- --------
Cash flows from financing activities:
Proceeds from issuance of Senior Secured
Notes net of discount of $4,026.......... -- -- -- 155,974 --
Costs associated with issuance of Senior
Secured Notes and warrants............... -- (133) (133) (5,237) --
Proceeds from issuance of 8% Series A
Convertible Preferred Stock, net of
issuance costs........................... -- 4,980 4,980 16,665 --
Proceeds from issuance of warrants......... -- -- -- 3,885 --
(Payments) proceeds on other long term
debt, net................................ (153) (92) 133 (164) --
Proceeds from issuance of common stock..... 240 647 63,751 6,015 11,126
-------- -------- -------- --------- --------
Net cash provided by financing
activities.......................... 87 5,402 68,731 177,138 11,126
-------- -------- -------- --------- --------
Net (decrease) increase in cash........ (5,914) (5,643) (33,168) 37,157 7,897
Cash and cash equivalents at beginning of
period..................................... 11,886 45,054 45,054 7,897 --
-------- -------- -------- --------- --------
Cash and cash equivalents at the end of
period..................................... 5,972 39,411 $ 11,886 $ 45,054 $ 7,897
-------- -------- -------- --------- --------
Supplemental schedule of non-cash investing
and financing activities:
Stock issued for services rendered......... $ -- $ -- $ -- $ -- $ 2
======== ======== ======== ========= ========
Increase in property and equipment
purchases included in accounts/notes
payable -- property and equipment........ $ -- $ 876 $ 15,504 $ 2,434 $ 1,372
======== ======== ======== ========= ========
Stock issued for notes receivable.......... $ -- $ 1,485 $ 1,485 $ 688 $ --
======== ======== ======== ========= ========
Warrants issued as consideration in debt
offering capitalized as deferred
financing costs.......................... $ -- $ -- $ -- $ 409 $ --
======== ======== ======== ========= ========
Other disclosures:
Cash paid for interest net of amounts
capitalized.............................. $ -- $ 305 $ 19,192 $ 164 $ --
======== ======== ======== ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 70
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999 AND DECEMBER 31, 1998
(INFORMATION AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998 IS
UNAUDITED)
(1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS
The accompanying consolidated financial statements of MGC Communications,
Inc. (the "Company"), a Nevada corporation, include the accounts of the Company
and its wholly-owned subsidiaries, MGC Lease Corporation and MGC LJ.Net, Inc.
All significant inter-company balances have been eliminated.
The Company was organized on October 16, 1995 as a competitive local
exchange carrier to provide low cost alternative communication services to
residential and small business users through the utilization of Company owned
switches and network architecture leased from incumbent local exchange carriers.
During the year ended December 31, 1998, the Company operated in Las Vegas,
Atlanta, Chicago, southern Florida, and selected areas of southern California
including Los Angeles and San Diego with substantially all of its operating
revenues being derived from the Las Vegas, southern California, and Atlanta
operations.
THREE MONTHS ENDED MARCH 31, 1999 AND 1998
The financial statements for the three months ended March 31, 1999 and 1998
and the related amounts in the Notes to Consolidated Financial Statements are
unaudited, but in the opinion of management reflect all normal and recurring
adjustments necessary for a fair presentation of the results of those periods.
REVENUE RECOGNITION
The Company recognizes operating revenues from communication services in
the period the related services are provided. Due to current disputes and
pending arbitration and litigation, the Company has recognized switched access
revenues based on management's best estimate of the probable collections from
such revenue. For the three months ended March 31, 1999 and 1998 and the years
ended December 31, 1998, 1997 and 1996, the Company has recognized in operating
revenues switched access revenues of approximately $2,975,000, $1,239,000,
$7,378,000, $730,000 and $0, respectively. Included in trade accounts receivable
in the accompanying balance sheets as of March 31, 1999 and December 31, 1998
and 1997 are receivables related to switched access of approximately $5,604,000,
$3,590,000 and $730,000, respectively.
CASH AND CASH EQUIVALENTS
The Company considers short-term investments with a remaining maturity of
three months or less at the date of purchase to be cash equivalents.
RESTRICTED INVESTMENTS
Restricted investments consist of U.S. Treasury Notes which are restricted
in that they must be used for the repayment of interest on certain debt and are
stated at amortized cost plus accrued interest. Management designated these
investments as held-to-maturity securities in accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." The carrying value of the
restricted investments approximates the fair value.
F-8
<PAGE> 71
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING COSTS
The Company expenses advertising costs in the period incurred. For the
years ended December 31, 1998, 1997 and 1996, the Company had expensed
advertising costs of $810,000, $125,000 and $0, respectively.
INVESTMENTS
Investments classified as available-for-sale at December 31, 1998 were
classified as held-to-maturity as of December 31, 1997. During the fourth
quarter of 1998, the Company sold investments, previously classified as
held-to-maturity, prior to their maturity date. In accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the
classification of these investments has been appropriately changed in the
accompanying consolidated financial statements.
Available-for-sale securities represent investments principally in
commercial paper and government securities. The commercial paper reflected as of
December 31, 1998 matures in March of 1999 and the government securities mature
periodically through September 30, 2001. The unamortized cost basis of these
investments at December 31, 1998 is approximately $72,246,000. The cost basis
for which the realized gain was calculated on available-for-sale securities was
$72,023,000 using the specific identification method.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated depreciation
and amortization. Direct and indirect costs of construction are capitalized, and
include $3,175,000 and $188,000 of interest costs related to construction during
1998 and 1997, respectively. Depreciation is computed using the straight-line
method over estimated useful lives beginning in the month an asset is put into
service.
Estimated useful lives of property and equipment are as follows:
<TABLE>
<S> <C>
Buildings................................ 40 years
Telecommunications and other switching
equipment.............................. 5-10 years
Computer hardware and software........... 3-5 years
Office furniture & equipment............. 3-5 years
Leasehold improvements................... the lesser of the estimated useful lives
or term of lease
</TABLE>
DEFERRED FINANCING COSTS
Deferred financing costs are amortized to interest expense over the life of
the related financing using the effective interest method.
INCOME TAXES
The Company has applied the provisions of SFAS No. 109, "Accounting for
Income Taxes," which requires the recognition of deferred tax assets and
liabilities for the consequences of temporary differences between amounts
reported for financial reporting and income tax purposes. SFAS No. 109 requires
recognition of a future tax benefit of net operating loss carryforwards and
certain other temporary differences to the extent that realization of such
benefit is more likely than not; otherwise, a valuation allowance is applied.
F-9
<PAGE> 72
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments,"
requires all entities to disclose the fair value of financial instruments, both
assets and liabilities recognized and not recognized on the balance sheet, for
which it is practicable to estimate fair value. SFAS No. 107 defines fair value
of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. At December 31, 1998
and 1997, the carrying value of all financial instruments (accounts receivable,
accounts payable and long-term debt) approximates fair value due to the short
term nature of the instruments or interest rates, which are comparable with
current rates.
LONG-LIVED ASSETS
Management periodically evaluates the carrying value of its long-lived
assets, including property, equipment and intangible assets, whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. To the extent the estimated future cash inflows attributable to the
asset, less estimated future cash outflows, is less than the carrying amount, an
impairment loss is recognized. Management believes no material impairment in the
value of long-lived assets exists at December 31, 1998 or 1997.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 requires companies to classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings, and is effective for financial statements issued for fiscal years
beginning after December 15, 1997. The Company has adopted SFAS No. 130 as
reflected in the accompanying consolidated 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 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 currently expenses all start-up costs as
incurred and the application of SOP 98-5 will have no material impact on the
Company's consolidated financial statements.
CONCENTRATION OF SUPPLIERS
The Company currently leases its transport capacity from a limited number
of suppliers and is dependent upon the availability of collocation space and
fiber optic transmission facilities owned by the suppliers. The Company is
currently vulnerable to the risk of renewing favorable supplier contracts,
timeliness of the supplier in processing the Company's orders for customers and
is at risk with regard to regulatory agreements that govern the rates to be
charged to the Company.
F-10
<PAGE> 73
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
RECLASSIFICATION
Certain reclassifications, which have no effect on net income, have been
made in the prior period financial statements to conform to the current
presentation.
(2) PLAN OF OPERATIONS
In September 1997, the Company completed an offering of units consisting of
in the aggregate $160 million of 13% Senior Secured Notes due in 2004 (the
"Notes") and warrants to purchase shares of common stock, as discussed in Note
4. During May and June 1998, the Company sold an aggregate of 4,025,000 shares
of common stock at $17.00 per share as discussed in Note 5. The Company expects
to continue its expansion into new markets and its development of new services.
The Company expects to fund its capital requirements through existing resources,
debt or equity financing and internally generated funds.
Management recognizes the Company must generate additional resources or
consider modifications to its expansion plans. To the extent the Company is
unable to achieve its funding plan, management has contingency plans which
include curtailing capital expenditure activities, reducing infrastructure costs
associated with expansion and development plans and achieving profitable
operations as soon as practicable. However, no assurance can be given the
Company will be successful in raising additional capital, achieving profitable
results, or entering into new markets.
Management also recognizes certain risks are inherent to the industry. Such
risks and assumptions include, but are not limited to, the Company's ability to
successfully market its existing and proposed services to current and new
customers in existing and planned markets, successfully develop commercially
viable data and Internet offerings, access markets, install switches and obtain
suitable locations for its switches, negotiate suitable interconnect agreements
with the ILECs, obtain an acceptable level of cooperation from the ILECs, all in
a timely manner, at reasonable cost and on satisfactory terms and conditions, as
well as competitive, regulatory, legislative and judicial developments that
could materially affect the Company's future results.
F-11
<PAGE> 74
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
MARCH 31, -------------------
1999 1998 1997
----------- -------- -------
(UNAUDITED)
<S> <C> <C> <C>
Buildings and property........................ $ 5,036 $ 2,653 $ 278
Switching equipment........................... 88,538 57,045 21,621
Leasehold improvements........................ 774 740 956
Computer hardware and software................ 2,691 2,218 1,404
Office equipment and vehicles................. 1,065 901 300
-------- -------- -------
98,104 63,557 24,559
Less accumulated depreciation and
amortization................................ (10,039) (6,555) (1,317)
-------- -------- -------
88,065 57,002 23,242
Switching equipment under construction........ 40,071 59,378 1,375
-------- -------- -------
Net property and equipment.................. $128,136 $116,380 $24,617
======== ======== =======
</TABLE>
(4) DEBT
Long-term borrowings at December 31, 1998 and 1997 consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
13% Senior Secured Notes, due October 1, 2004, net of
unamortized discount of $3,307 and $3,882............... $156,693 $156,118
10% note payable in monthly installments through February
1999.................................................... 225 441
Other..................................................... 377 78
-------- --------
157,295 156,637
Less current portion...................................... (332) (381)
-------- --------
$156,963 $156,256
======== ========
</TABLE>
F-12
<PAGE> 75
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturities of long-term debt for each of the next six years ending December
31, consist of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
1999...................................................... $ 332
2000...................................................... 174
2001...................................................... 96
2002...................................................... --
2003...................................................... --
2004...................................................... 156,693
--------
$157,295
========
</TABLE>
In September 1997, the Company completed an offering of units consisting of
in the aggregate $160 million of 13% Senior Secured Notes due in 2004 and
warrants to purchase 774,720 shares of common stock (collectively the "1997
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 consolidated
financial statements reflect approximately $39.4 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,
1998, the Notes were secured by a security interest in telecommunications
equipment with a net book value of $85.3 million.
In conjunction with the 1997 Offering, the Company engaged an
investment-banking firm that determined a value for each warrant and share of
common stock. Consistent with this determination, the Company has allocated a
portion of the 1997 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 specified in
the warrant agreement.
The warrants are currently exercisable and expire on October 1, 2004. The
agreement pursuant to which the warrants were issued required an anti-dilution
adjustment if the November 1997 preferred stock offering was consummated at a
price less than $5.00 per share. As further discussed in Note 5, the Company
completed the November 1997 preferred stock offering for $3.50 per share.
Accordingly, the warrants issued in connection with the 1997 Offering were
increased from 774,200 to 862,923 and have been reflected in the accompanying
consolidated financial statements as of December 31, 1998 and 1997. Expenses
allocated to the warrants in connection with the 1997 Offering were $141,000.
In conjunction with the 1997 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.
F-13
<PAGE> 76
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has recorded the commitment fee as non-cash consideration in
connection with the 1997 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 specified in the
warrant agreement. 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:
<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 may, 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 remains outstanding immediately
after the occurrence of such redemption. As of the date of these consolidated
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, 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, 1998, management believes it is in compliance
with all debt covenants.
In conjunction with the 1997 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 in 1997.
(5) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
COMMON STOCK
On December 6, 1996, the Board of Directors approved a four-hundred-for-one
stock split, effected in the form of a stock dividend distributed on December
31, 1996 to shareholders of record as of June 8, 1996. All share and per share
data presented in the consolidated financial statements and notes thereto have
been retroactively restated to give effect to this stock split.
F-14
<PAGE> 77
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1995, in exchange for expending cash to incorporate the Company, a
shareholder received 240,000 shares of $.001 par value common stock valued at
$.0042 per share. The Company capitalized the value of the issued shares as
organization costs included in other assets in the accompanying consolidated
financial statements, which costs are being amortized over 60 months using the
straight-line method.
In April 1996, the Company issued 480,000 shares of $.001 par value common
stock valued at $.0042 per share in exchange for services rendered by a
stockholder.
During 1996, NevTEL LLC ("LLC") was formed for the purpose of funding the
development stage of MGC Communications, Inc. In June 1996, the Company and LLC
entered into an agreement whereby LLC would acquire 3,696,000 shares of $.001
par value common stock of the Company for $.83 per share. The agreement called
for LLC to advance funds for operating expenses incurred by the Company (to be
applied against the purchase price of the stock) until the Company produced
operating revenues, at which time the remaining purchase price would be remitted
to the Company, the Company's common stock would be issued to LLC owners and LLC
would terminate. The agreement stipulated that the funds advanced for operating
expenses were to be paid back to LLC if the Company did not generate operating
revenue by December 31, 1996. The Company began revenue generating activities in
December 1996. The shares were issued to LLC owners on December 31, 1996, at
which time LLC terminated and the remaining purchase price was owed to the
Company. Such amount was transferred to the Company in February 1997 and is
classified as amounts receivable for shares issued at December 31, 1996.
In December 1996, the Company offered 4,068,600 shares of $.001 par value
common stock at $3.33 per share through a private placement. In connection with
this offering, the Company issued 1,308,600 shares and 2,760,000 shares of $.001
par value common stock and received proceeds of $4,362,000 and $9,200,000 during
the years ended December 31, 1997 and 1996, respectively.
In June 1997, the Company approved agreements with two key members of
management granting them rights to purchase a total of 150,000 shares at $3.33
per share and 165,000 shares at $4.17 per share. In both cases, the Company
retains the right to repurchase these shares at their cost in the event of
termination of employment for any reason and has agreed to finance the purchase
price of the shares 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 consolidated statements of redeemable preferred stock and
stockholders' equity as notes receivable from stockholders for issuance of
common stock.
During 1998, the Company issued 100,680 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 $774,000.
During 1998, the Company approved agreements with 11 key members of
management to purchase a total of 189,000 shares of common stock. The purchase
price of these shares ranged from $5.83 to $8.33 per share. In each case, the
Company retains the right to repurchase these shares at their cost in the event
of termination of employment for any reason and has agreed to finance a portion
of the purchase price of the shares over a period of three years. 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.
F-15
<PAGE> 78
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During May and June 1998, the Company sold 4,025,000 shares of common stock
at $17.00 per share pursuant to a registration statement 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 consolidated financial statements. In addition to the reverse
stock split, the Company's 6,571,427 outstanding shares of 8% Series A
Convertible Preferred Stock (the "Series A Preferred Stock") as discussed below,
were converted to 3,942,839 shares of the Company's common stock upon completion
of the initial public offering. The conversion of the Series A Preferred Stock
has been reflected in the accompanying consolidated 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.
In November 1997, the Company completed a private placement offering in
which 5,148,570 shares of the Series A 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 Series A 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 Series A 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 Series A Preferred Stock, the accrued
dividends were reversed at the time of conversion.
(6) STOCK OPTION PLAN
In June 1996, the Company adopted a stock option plan which allows the
Board of Directors to grant incentives to employees in the form of incentive
stock options and non-qualified stock options. As of December 31, 1997, the
Company had reserved 1,440,000 shares of common stock to be issued under the
plan. In March 1998, the Board of Directors approved an additional 1,200,000
shares of common stock to be issued under the plan.
In July 1998, the Company filed a registration statement on Form S-8 to
register the shares of the Company's common stock reserved for issuance under
the MGC Communications, Inc. Stock Option Plan.
Under the plan, substantially all options have been granted to employees at
a price equal to the then-current market price, as estimated by management, and
vest primarily over a 5-year period. All options expire within ten years of the
date of grant.
F-16
<PAGE> 79
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock option transactions during 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- --------
<S> <C> <C>
Outstanding at December 31, 1995.......................... -- --
Granted................................................... 811,860 $1.35
Canceled.................................................. (30,000) $1.67
---------
Outstanding at December 31, 1996.......................... 781,860 $1.35
Granted................................................... 274,560 $5.78
Canceled.................................................. (3,300) $5.08
---------
Outstanding at December 31, 1997.......................... 1,053,120 $2.50
Granted................................................... 865,700 $8.48
Exercised................................................. (7,380) $1.77
Canceled.................................................. (85,240) $5.84
---------
Outstanding at December 31, 1998.......................... 1,826,200 $5.18
=========
Exercisable at December 31, 1996.......................... 11,760 $3.33
=========
Exercisable at December 31, 1997.......................... 165,720 $1.47
=========
Exercisable at December 31, 1998.......................... 378,660 $2.07
=========
</TABLE>
For options granted during the year ended December 31, 1998, the weighted
average fair value of options on the date of grant, estimated using the
Black-Scholes option pricing model, was $6.70 using the following assumptions:
dividend yield of 0%; expected option life of 6.5 years; and risk free interest
rate of 5.06% and an expected volatility of 80.5%.
The weighted average fair value of the options issued during the years
ended December 31, 1997 and 1996, substantially all of which were granted at a
price equal to the then current market price as estimated by management, was
estimated to be $4.03 and $.92, respectively, using an option pricing model with
the following assumptions: dividend yield of 0%; expected option life of 6.5
years; and risk free interest rate at December 31, 1997 and 1996 of 5.06% and
6.12%, respectively.
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
RANGE OF AT DEC. 31, CONTRACTUAL EXERCISE AT DEC. 31, EXERCISE
EXERCISE PRICE 1998 LIFE PRICE 1998 PRICE
- ---------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.83 to $3.50 745,980 7.38 years $ 1.33 320,400 $1.37
$5.00 to $6.50 488,920 8.97 years $ 5.99 56,760 $5.84
$7.50 to $10.00 496,800 9.58 years $ 8.45 1,500 $8.33
$12.50 to $17.00 94,500 9.44 years $14.10 -- $ --
--------- -------
$0.83 to $17.00 1,826,200 8.51 years $ 5.18 378,660 $2.07
========= =======
</TABLE>
F-17
<PAGE> 80
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company applied Accounting Principles Board Opinion No. 25 in
accounting for its plan. No compensation expense was recognized for the years
ended December 31, 1998, 1997 and 1996. Had the Company determined compensation
expense using the fair value based method defined in SFAS No. 123, the Company's
loss for the years then ended would have increased by $565,000, $7,000 and
$10,000, respectively.
(7) LOSS PER SHARE
SFAS No. 128, "Earnings Per Share," requires the Company to calculate its
earnings per share based on basic and diluted earnings per share, as defined.
Basic and diluted loss per share for the years ended December 31, 1998, 1997 and
1996 were computed by dividing net loss applicable to common stockholders by the
weighted average number of shares of common stock outstanding.
The Company's warrants, preferred stock and stock options granted and
issued during 1998, 1997 and 1996, and outstanding as of December 31, 1998 and
1997, are antidilutive and have been excluded from the diluted loss per share
calculation for the years ended December 31, 1998, 1997 and 1996. Had the
Company shown the effects of dilution, the warrants, preferred stock and options
would have added an additional 1.8 million, 1.6 million and 0.5 million shares
to the weighted average shares outstanding for the years ended December 31,
1998, 1997 and 1996, respectively.
(8) INCOME TAXES
The net deferred tax asset as of December 31, 1998 and 1997 is as follows
(in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
Deferred Tax Asset
Net operating loss carry-forward......................... $ 17,804 $ 4,529
Start-up expenditures.................................... 164 220
Other.................................................... 534 141
-------- -------
18,502 4,890
Less: valuation allowance................................ (15,517) (4,309)
-------- -------
Net deferred tax asset................................... 2,985 581
-------- -------
Deferred Tax Liability
Excess of tax depreciation over book..................... 2,769 481
Other.................................................... 216 100
-------- -------
Net deferred tax liability............................... 2,985 581
-------- -------
Net........................................................ $ -- $ --
======== =======
</TABLE>
SFAS No. 109 requires recognition of the future tax benefit of these assets
to the extent realization of such benefits is more likely than not; otherwise, a
valuation allowance is applied. At December 31, 1998 and 1997, the Company
determined that $15,517,000 and $4,309,000, respectively, of tax benefits did
not meet the realization criteria because of the Company's historical operating
results. Accordingly, a valuation allowance was applied to reserve against the
applicable deferred tax asset.
At December 31, 1998 and 1997, the Company had net operating loss
carry-forwards available for income tax purposes of approximately $50,869,000
and $12,940,000, respectively, which expire principally from 2011 to 2018.
F-18
<PAGE> 81
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) COMMITMENTS AND CONTINGENCIES
LEASE OBLIGATIONS
The Company has entered into various leasing agreements for its switching
facilities, offices, and office equipment. The facility which houses the
Company's headquarters in Las Vegas is owned by an entity principally owned by
two of the Company's principal stockholders and directors. Management believes
the terms and conditions of this agreement are equal to the terms which would be
available from an unaffiliated lessor.
Future minimum lease obligations in effect as of December 31, 1998 are as
follows (in thousands):
<TABLE>
<S> <C>
Payments during the year ending December 31:
1999...................................................... $1,389
2000...................................................... 1,272
2001...................................................... 1,166
2002...................................................... 977
2003...................................................... 159
Thereafter................................................ 342
------
$5,305
======
</TABLE>
Rent expense was $850,000, $207,000 and $33,000 for the years ended
December 31, 1998, 1997 and 1996, respectively, of which $614,000 was paid to a
related party during 1998.
PURCHASE COMMITMENTS
In the ordinary course of business, the Company enters into purchase
agreements with its vendors of telecommunications equipment. As of March 31,
1999 and December 31, 1998, the Company had a total for all vendors of
approximately $19.0 million and $15.4 million, respectively, of remaining
purchase commitments for purchases of switching equipment.
LITIGATION
The Company is party to various legal proceedings, most of which relate to
routine matters incidental to its business. Management does not believe that the
outcome of such proceedings will have a material adverse effect on the Company's
financial position or results of operations.
INTERCONNECTION AGREEMENTS
The Company has interconnection agreements with five incumbent local
exchange carriers. These agreements expire on various dates through July 2000.
The Company is dependent on the cooperation of the incumbent local exchange
carriers to provide access service for the origination and termination of its
local and long distance traffic. Historically, these access charges can make up
a significant percentage of the overall cost of providing these services. To the
extent the access services of the local exchange carriers are used, the Company
and its customers are subject to the quality of service, equipment failures and
service interruptions of the local exchange carriers.
(10) RISKS AND UNCERTAINTIES
Certain rates in the interconnection agreements have been established by
the Federal Communications Commission (FCC) and are subject to adjustment upon
final negotiations. The Company has recorded costs of operating revenues related
to the Sprint (Nevada) interconnection
F-19
<PAGE> 82
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
agreement at amounts which are management's best estimates of the probable
outcome of the final negotiated rates, which are less than the FCC established
rates. The difference, which totals approximately $2.2 million, $1.7 million and
$1.1 million at March 31, 1999, December 31, 1998 and 1997, respectively, has
not been recorded in the accompanying consolidated financial statements.
Management believes that the resolution of this matter will not have an adverse
effect on the Company's consolidated financial position, results of operations,
or liquidity.
(11) RELATED PARTY TRANSACTION
In May 1997, the Company entered into an agreement with a company, the
owner of which is a former officer and current stockholder of the Company, for
the purchase of certain computer software pursuant to which the Company paid the
contract price of $600,000 in six equal monthly installments beginning July 1,
1997. In addition, the Company has paid $656,000 and $40,000 during 1998 and
1997, respectively, under such agreement to support and maintain the Company's
proprietary operations support system. Management believes the terms and
conditions of this agreement are equal to the terms which would be available
from an unaffiliated party.
(12) SUBSEQUENT EVENTS (UNAUDITED)
PREFERRED STOCK OFFERING
On April 5, 1999, the Company entered into a Securities Purchase Agreement
with Providence Equity Partners III L.P. ("Providence"), JK&B Capital III L.P.
("JK&B III") and Wind Point Partners III L.P. ("Wind Point") under which
Providence, JK&B III and Wind Point and their affiliates (the "Purchasers")
agreed to purchase 5,277,779 shares of newly issued Series B Convertible
Preferred Stock ("Series B Preferred Stock") at $9.00 per share(the
"Transaction") for a total consideration of $47.5 million. Net proceeds to the
Company were approximately $46.5 million.
Dividends accrue on the Series B Preferred Stock at the rate of 10% per
annum, are cumulative and are payable in preference to any dividends that may be
paid with respect to the Company's Common Stock. Beginning 201 days after the
closing, the Company may elect to terminate the accrual of dividends if the
Company's stock price exceeds $27.00 per share (subject to certain adjustments)
for 20 consecutive trading days (the "Market Threshold") within three years
after the closing. The Transaction was consummated on May 4, 1999. The Series B
Preferred Stock will vote along with the Common Stock on an as-converted basis.
The holders of the Series B Preferred Stock have the right to nominate one
or more directors depending on the size of the Company's Board of Directors and
the percentage of the Company's stock represented by the outstanding Series B
Preferred Stock. The holders of the Series B Preferred Stock also have the right
to have their Board representative serve on each committee of the Company's
Board and on the Board of each of the Company's subsidiaries.
The Series B Preferred Stock is convertible into Common Stock at any time
at the option of the holder. Initially, each share of Series B Preferred Stock
is convertible into one share of Common Stock. The conversion price is subject
to adjustment as a result of stock splits, stock dividends and certain other
issuances of additional stock.
After the earlier of May 24, 2000 or the date on which the holders of
Series B Preferred Stock exercise their demand registration rights, the Company
has the right to require the conversion of the Series B Preferred Stock if the
Company's stock price exceeds the Market Threshold referenced above. If the
Company requires conversion within three years after closing, no accrued
dividends will be paid.
F-20
<PAGE> 83
- ------------------------------------------------------
- ------------------------------------------------------
WE HAVE NOT AUTHORIZED ANY DEALER, SALESPERSON OR OTHER PERSON TO GIVE ANY
INFORMATION OR REPRESENT ANYTHING NOT CONTAINED IN THIS PROSPECTUS. YOU MUST NOT
RELY ON ANY UNAUTHORIZED INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL
AND IS NOT A SOLICITATION OF AN OFFER TO BUY THESE SECURITIES IN ANY
JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. THE INFORMATION IN THIS
PROSPECTUS IS CORRECT ONLY AS OF THE DATE OF THIS PROSPECTUS.
--------------------------------
TABLE OF CONTENTS
--------------------------------
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................. 3
Risk Factors........................ 9
How We Intend to Use the Proceeds Of
this Offering..................... 21
Dividend Policy..................... 21
Capitalization...................... 22
Dilution............................ 23
Selected Consolidated Financial and
Operating Data.................... 24
Management's Discussion and Analysis
of Financial Condition and Results
of Operations..................... 25
Business............................ 30
Management.......................... 48
Principal and Selling
Stockholders...................... 51
Description of Securities........... 53
Underwriting........................ 59
Legal Matters....................... 61
Experts............................. 61
Where You Can Find More
Information....................... 61
Index to Financial Statements....... F-1
</TABLE>
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
5,587,695 SHARES
[MGC LOGO]
MGC COMMUNICATIONS, INC.
COMMON STOCK
--------------------
PROSPECTUS
--------------------
BEAR, STEARNS & CO. INC.
GOLDMAN, SACHS & CO.
ING BARINGS
, 1999
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 84
MGC COMMUNICATIONS, INC.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The fees and expenses to be paid in connection with this offering are as
follows:
<TABLE>
<S> <C>
SEC filing fee.............................................. $41,818,000
NASD filing fee............................................. 17,750.00
NASDAQ listing fee.......................................... 17,500.00
Accounting fees and expenses*............................... 150,000.00
Legal fees and expenses*.................................... 150,000.00
Printing expenses*.......................................... 150,000.00
Miscellaneous*.............................................. 122,932,000
-----------
Total............................................. $650,000.00
===========
</TABLE>
- ---------------
* Estimated
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Articles of Incorporation of the Company provide that directors of the
Company will not be personally liable for monetary damages to the Company for
certain breaches of their fiduciary duty as directors to the fullest extent
allowable by Nevada law. Under current Nevada law, directors would remain liable
for: (i) acts or omissions which involve intentional misconduct, fraud or a
knowing violation of law, and (ii) approval of certain illegal dividends or
redemptions. In appropriate circumstances, equitable remedies or nonmonetary
relief, such as an injunction, will remain available to a stockholder seeking
redress from any such violation. In addition, the provision applies only to
claims against a director arising out of his role as a director and not in any
other capacity (such as an officer or employee of the Company).
The Company also has the obligation, pursuant to its By-laws, to indemnify
any director or officer of the Company for all expenses incurred by them in
connection with any legal action brought or threatened against such person for
or on account of any action or omission alleged to have been committed while
acting in the course and scope of the person's duties, if the person acted in
good faith and in a manner which the person reasonably believed to be in or not
opposed to the best interests of the Company, and with respect to criminal
actions, had no reasonable cause to believe the person's conduct was unlawful,
provided that such indemnification is made pursuant to then existing provisions
of Nevada General Corporation Law at the time of any such indemnification.
II-1
<PAGE> 85
ITEM 16. EXHIBITS
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. AND DESCRIPTION
---------------------------
<S> <C>
1.1 Underwriting Agreement.
4.1 Articles of Incorporation and Amendments.(1)
4.2 By-laws.(2)
4.3 Stockholders' Agreement dated as of November 26, 1997, among
the Company, Maurice J. Gallagher, Jr., Nield J. Montgomery
and certain investors identified therein.(1)
4.4 Indenture dated as of September 29, 1997, between the
Company and Marine Midland Bank, as Trustee.(1)
4.5 Warrant Registration Rights Agreement dated as of September
29, 1997, among the Company, Bear, Stearns & Co. Inc. and
Furman Selz LLC.(1)
4.6 Certificate of Designation of Series B Convertible Preferred
Stock.(3)
4.7 Registration Rights Agreement dated May 4, 1999, among the
Company and the purchasers of Series B Convertible Preferred
Stock.(3)
4.8 Securityholders' Agreement dated April 5, 1999, among the
Company, the purchasers of Series B Convertible Preferred
Stock and certain stockholders of the Company.(3)
4.9 Certificate of Change in Authorized Capital of MGC
Communications, Inc.(4)
5.1 Legal Opinion of Ellis, Funk, Goldberg, Labovitz & Dokson,
P.C.
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of KPMG LLP.
</TABLE>
- ---------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-4, registration number 333-33837, filed with the Commission on August 18,
1997, and amendments thereto.
(2) Incorporated by reference to the Company's Registration Statement on Form
S-1, registration statement number 333-49085, filed with the Commission on
April 1, 1998, and amendments thereto.
(3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1999, Commission File No. 0-26914, filed with
the Commission on May 17, 1999.
(4) Previously filed as an Exhibit to this Registration Statement.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes that for purposes of
determining any liability under the Securities Act of 1933:
(1) the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
(3) each filing of the Registrant's annual report pursuant to Section
13(a) or Section 15(d) of the Securities Exchange Act of 1934 (and, where
applicable, each filing of an employee benefit plan's annual report
pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is
incorporated by reference in the registration statement shall be deemed to
be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
II-2
<PAGE> 86
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-3
<PAGE> 87
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Amendment No. 3 to
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Las Vegas, State of Nevada on the 21st day of
July, 1999.
MGC COMMUNICATIONS, INC.
By: /s/ NIELD J. MONTGOMERY
--------------------------------------
Nield J. Montgomery, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 3 to Registration Statement has been signed by the following persons in the
capacities indicated.
<TABLE>
<S> <C> <C>
/s/ NIELD J. MONTGOMERY July 21, 1999
- ---------------------------------------------------
Nield J. Montgomery, President
(Chief Executive Officer) and Director
/s/ LINDA M. SUNBURY July 21, 1999
- ---------------------------------------------------
Linda M. Sunbury, Senior Vice President
(Chief Financial Officer and Principal Accounting
Officer)
* July 21, 1999
- ---------------------------------------------------
Maurice J. Gallagher, Jr., Director
(Chairman of the Board)
* July 21, 1999
- ---------------------------------------------------
Timothy P. Flynn, Director
* July 21, 1999
- ---------------------------------------------------
Jack L. Hancock, Director
* July 21, 1999
- ---------------------------------------------------
David Kronfeld, Director
* July 21, 1999
- ------------------------------------------
Thomas Neustaetter, Director
* July 21, 1999
- ------------------------------------------
Paul J. Salem, Director
*By: /s/ LINDA M. SUNBURY
-----------------------------------------
Linda M. Sunbury
Attorney-in-fact
</TABLE>
II-4
<PAGE> 88
EXHIBIT INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
1.1 Underwriting Agreement......................................
4.1 Articles of Incorporation and Amendments.(1)................
4.2 By-laws.(2).................................................
4.3 Stockholders' Agreement dated as of November 26, 1997, among
the Company, Maurice J. Gallagher, Jr., Nield J. Montgomery
and certain investors identified therein.(1)................
4.4 Indenture dated as of September 29, 1997, between the
Company and Marine Midland Bank, as Trustee.(1).............
4.5 Warrant Registration Rights Agreement dated as of September
29, 1997, among the Company, Bear, Stearns & Co. Inc. and
Furman Selz LLC.(1).........................................
4.6 Certificate of Designation of Series B Convertible Preferred
Stock.(3)...................................................
4.7 Registration Rights Agreement dated May 4, 1999, among the
Company and the purchasers of Series B Convertible Preferred
Stock.(3)...................................................
4.8 Securityholders' Agreement dated April 5, 1999, among the
Company, the purchasers of Series B Convertible Preferred
Stock and certain stockholders of the Company.(3)...........
4.9 Certificate of Change in Authorized Capital of MGC
Communications, Inc.(4).....................................
5.1 Legal Opinion of Ellis, Funk, Goldberg, Labovitz & Dokson,
P.C.........................................................
23.1 Consent of Arthur Andersen LLP..............................
23.2 Consent of KPMG LLP.........................................
</TABLE>
- ---------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-4, registration number 333-33837, filed with the Commission on August 18,
1997, and amendments thereto.
(2) Incorporated by reference to the Company's Registration Statement on Form
S-1, registration statement number 333-49085, filed with the Commission on
April 1, 1998, and amendments thereto.
(3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1999, Commission File No. 0-26914, filed with
the Commission on May 17, 1999.
(4) Previously filed as an Exhibit to this Registration Statement.
<PAGE> 1
EXHIBIT 1.1
__________ Shares
MGC COMMUNICATIONS, INC.
Common Stock
UNDERWRITING AGREEMENT
July __, 1999
BEAR, STEARNS & CO. INC.
GOLDMAN, SACHS & CO.
ING BARINGS LLC
c/o Bear, Stearns & Co. Inc.
245 Park Avenue
New York, New York 10167
Ladies and Gentlemen:
MGC Communications, Inc., a Nevada corporation (the "Company") and the
stockholders of the Company listed on Schedule I hereto (collectively, the
"Selling Stockholders" and, together with the Company, the "Sellers"), confirm
their agreement with Bear, Stearns & Co. Inc. ("Bear Stearns"), Goldman, Sachs
& Co. and ING Barings LLC (the "Underwriters"), as follows:
1. Description of Securities. The Company and the Selling Stockholders
severally propose, upon the terms and subject to the conditions set forth
herein, to issue and sell to the Underwriters an aggregate of _____________
shares (the "Firm Shares") of the Company's common stock, $0.001 par value per
share (the "Common Stock"). The Firm Shares consist of __________ million
shares to be issued and sold by the Company (the "Firm Company Shares") and
___________ outstanding shares to be sold by the Selling Stockholders. The
Company also proposes to sell to the Underwriters, upon the terms and subject
to the conditions set forth in Section 3 hereof, up to an additional _______
shares (the "Additional Shares" and together with the Firm Company Shares, the
"Company Shares"). The Firm Shares and the Additional Shares are hereinafter
collectively referred to as the "Shares."
2. Registration Statement and Prospectus. The Company has prepared and
filed with the Securities and Exchange Commission (the "Commission") in
conformity with the requirements of the Securities Act of 1933, as amended (the
"Act"), and the rules and regulations promulgated thereunder by the Commission
(the "Securities Act Regulations"; which together with the Exchange Act
Regulations (as defined below), are referred to herein as the "Regulations"), a
registration statement, as amended by certain amendments thereto, on Form S-3
(File No. 333-79863), including a preliminary prospectus, subject to
completion, relating to the Shares. The Company will next file with the
Commission either (i) prior to the effectiveness of such registration
statement, a further amendment thereto, including therein a
<PAGE> 2
final prospectus or (ii) after the effectiveness of such registration
statement, a final prospectus in accordance with Rules 430A and 424(b)(1) of
the Securities Act Regulations, the documents so filed in either case to
include all Rule 430A Information (as defined below) and to conform, in content
and form, to the last printer's proof thereof furnished to and approved by the
Underwriters immediately prior to such filing. If the Company files a
registration statement to register a portion of the Shares and relies on Rule
462(b) for such registration statement to become effective upon filing with the
Commission (the "Rule 462 Registration Statement"), then any reference to
"Registration Statement" herein shall be deemed to be both the registration
statement referred to above (No. 333-79863) and the Rule 462 Registration
Statement, as each such registration statement may be amended pursuant to the
Act.
As used in this Underwriting Agreement (the "Agreement"), (i) the term
"Effective Date" means the later of the date the registration statement is
declared effective by the Commission, or, if a post-effective amendment is
filed with respect thereto, the date of such post-effective amendment's
effectiveness, (ii) the term "Registration Statement" means the registration
statement, as amended at the time when it becomes effective or, if a
post-effective amendment is filed with respect thereto, as amended by such
post-effective amendment at the time of its effectiveness, including in each
case all information incorporated by reference therein, all Rule 430A
Information deemed to be included therein at the Effective Date pursuant to
Rule 430A of the Securities Act Regulations and all financial statements and
exhibits included or incorporated by reference therein, (iii) the term "Rule
430A Information" means information with respect to the Shares and the public
offering thereof permitted, pursuant to the provisions of paragraph (a) of Rule
430A of the Securities Act Regulations, to be omitted from the form of
prospectus included in the Registration Statement at the time it is declared
effective by the Commission, (iv) the term "Prospectus" means the form of final
prospectus relating to the Shares first filed with the Commission pursuant to
Rule 424(b) of the Securities Act Regulations or, if no filing pursuant to Rule
424(b) is required, the form of final prospectus included in the Registration
Statement at the Effective Date and (v) the term "preliminary prospectus" means
any preliminary prospectus (as described in Rule 430 of the Securities Act
Regulations) with respect to the Shares that omits Rule 430A Information. Any
reference herein to the Registration Statement, the Prospectus, any amendment
or supplement thereto or any preliminary prospectus shall be deemed to refer to
and include the documents incorporated by reference therein which were filed
under the Securities Exchange Act of 1934, as amended (the "Exchange Act") and
the rules and regulations of the Commission promulgated thereunder (the
"Exchange Act Regulations"), and any reference herein to the terms "amend,"
"amendment" or "supplement" with respect to the Registration Statement or
Prospectus shall be deemed to refer to and include the filing after the
execution hereof of any document with the Commission deemed to be incorporated
by reference therein. For purposes of this Agreement the term "subsidiaries"
shall mean MGC Lease Corporation, a Nevada corporation, MGC License
Corporation, a Georgia corporation and MGC LJ.Net, Inc., a Nevada corporation,
and shall include those corporations, partnerships and other business entities,
whether domestic or foreign, which are, or under generally accepted accounting
principles should be, consolidated for purposes of the Company's financial
reporting.
3. Purchase and Sale of the Shares. Subject to all the terms and
conditions set forth herein (i) the Company agrees to issue and sell
_______________ Firm Shares and (ii) each Selling Stockholder agrees, severally
and not jointly, to sell the number of Firm Shares
<PAGE> 3
set forth opposite such Selling Stockholder's name on Schedule I hereto to the
Underwriters and, upon the basis of the representations, warranties, covenants
and agreements of the Company and the Selling Stockholders herein contained and
subject to all the terms and conditions set forth herein, each Underwriter
agrees, severally and not jointly, to purchase from the Company and the Selling
Stockholders, at a purchase price of $_____ per Share, the number of Firm Shares
set forth opposite the name of such Underwriter on Schedule II hereto (or such
number of Firm Shares increased as set forth in Section 12 hereof).
The Company also agrees, subject to all the terms and conditions set forth
herein, to sell to the Underwriters, and, upon the basis of the representations,
warranties and agreements of the Company herein contained and subject to all the
terms and conditions set forth herein, the Underwriters shall have the right to
purchase from the Company, solely for the purpose of covering over-allotments in
connection with sales of the Firm Shares, at the purchase price per Share of
$_____, pursuant to an option (the "over-allotment option") which may be
exercised at any time and from time to time prior to 9:00 p.m., New York City
time, on the 30th day after the date of the Prospectus (or, if such 30th day
shall be a Saturday or Sunday or a holiday, on the next business day thereafter
when the New York Stock Exchange is open for trading), up to an aggregate of
__________ Additional Shares. Upon any exercise of the over-allotment option,
each Underwriter, severally and not jointly, agrees to purchase from the Company
the number of Additional Shares (subject to such adjustments as the Underwriters
may determine in order to avoid fractional shares) that bears the same
proportion to the aggregate number of Additional Shares to be purchased by the
Underwriters as the number of Firm Shares set forth opposite the name of such
Underwriter on Schedule II hereto (or such number of Firm Shares increased as
set forth in Section 12 hereof) bears to the aggregate number of Firm Shares.
The Sellers hereby agree, severally and not jointly, and the Company
shall, concurrently with the execution of this Agreement, deliver agreements
substantially in the form attached hereto as Exhibit D executed by each of the
directors and officers of the Company and by each stockholder listed on Schedule
III hereto, pursuant to which each such person agrees, not to offer, sell,
contract to sell, grant any option to purchase, or otherwise dispose of, any
Common Stock of the Company or any securities convertible into or exercisable or
exchangeable for such Common Stock, for a period of 90 days after the date of
the Prospectus, except to the Underwriters pursuant to this Agreement.
Notwithstanding the foregoing, during such period the Company may (i) issue
shares of its Common Stock and grant stock options pursuant to the Company's
existing Stock Option Plan (the "Stock Option Plan"), (ii) issue shares of its
Common Stock upon the exercise of an option or warrant or the conversion of a
security outstanding on the date hereof and (iii) issue shares of its Common
Stock and grant options to newly hired management level employees consistent
with past practices of the Company.
4. Offering. It is understood that the Underwriters propose to make a
public offering of their respective portions of the Shares as soon after the
Registration Statement and this Agreement have become effective as in the
Underwriters' judgment is advisable and initially to offer the Shares for sale
to the public as set forth in the Prospectus.
5. Delivery of the Shares and Payment Therefor. Delivery to the
Underwriters of
<PAGE> 4
and payment for the Firm Shares shall be made at the office of Kronish Lieb
Weiner & Hellman LLP, 1114 Avenue of the Americas, New York, NY 10036, at 10:00
a.m., New York City time, on __________, 1999 (the "Closing Date"). The place of
closing for the Firm Shares and the Closing Date may be varied by agreement
between the Underwriters and the Company.
Delivery to the Underwriters of and payment for any Additional Shares to
be purchased by the Underwriters shall be made at the office of Kronish Lieb
Weiner & Hellman LLP, 1114 Avenue of the Americas, New York, NY 10036 at such
time and on such date (the "Option Closing Date"), which may be the same as the
Closing Date but shall in no event be earlier than the Closing Date nor earlier
than two nor later than ten business days after the giving of the notice
hereinafter referred to, as shall be specified in a written notice from the
Underwriters to the Company of the Underwriters' determination to purchase a
number, specified in such notice, of Additional Shares. The place of closing for
any Additional Shares and the Option Closing Date for such Shares may be varied
by agreement between the Underwriters and the Company.
Certificates for the Firm Shares and for any Additional Shares to be
purchased hereunder shall be registered in such names and in such denominations
as the Underwriters shall request prior to 9:30 a.m., New York City time, on the
second business day preceding the Closing Date or the Option Closing Date, as
the case may be. Such certificates shall be made available to the Underwriters
in New York City for inspection and packaging not later than 9:30 a.m., New York
City time, on the business day next preceding the Closing Date or the Option
Closing Date, as the case may be. The certificates evidencing the Firm Shares
and any Additional Shares to be purchased hereunder shall be delivered to the
Underwriters on the Closing Date or the Option Closing Date, as the case may be,
against payment of the purchase price therefor by wire transfer of immediately
available funds to the Company's and each of the Selling Stockholders' accounts,
provided that each of the Company and the Selling Stockholders shall give at
least two business days' prior written notice to the Underwriters of the
information required to effect such wire transfers.
6. Covenants of the Company. The Company covenants and agrees with
each of the Underwriters as follows:
(a) The Company will, if the Registration Statement has not
heretofore become effective under the Act, file an amendment to the
Registration Statement or, if necessary pursuant to Rule 430A of the
Securities Act Regulations, file a post-effective amendment to the
Registration Statement, as soon as practicable after the execution and
delivery of this Agreement, and will use its best efforts to cause the
Registration Statement or such post-effective amendment to become
effective at the earliest possible time. If the Registration Statement
has become or becomes effective pursuant to Rule 430A of the Securities
Act Regulations, or filing of the Prospectus is otherwise required under
Rule 424(b) of the Securities Act Regulations, the Company will file the
Prospectus, properly completed, pursuant to Rule 424(b) of the Securities
Act Regulations within the time period therein prescribed and will
provide evidence satisfactory to the Underwriters of such timely filing.
The Company in all other respects will comply fully and in a timely
manner with the applicable provisions of
<PAGE> 5
Rule 424 and Rule 430A of the Securities Act Regulations and with Rule 462
of the Securities Act Regulations, if applicable.
(b) The Company will promptly advise the Underwriters, and, if
requested by the Underwriters, confirm such advice in writing, (i) when
the Registration Statement, any Rule 462 Registration Statement or any
post-effective amendment thereto has become effective and if and when the
Prospectus is sent for filing pursuant to Rule 424(b) of the Securities
Act Regulations, (ii) of receipt by the Company or any representative or
attorney of the Company of any communications from the Commission
relating to the Company, the Registration Statement, any preliminary
prospectus, the Prospectus, any document incorporated by reference
therein, or the transactions contemplated by this Agreement, including,
without limitation, the receipt of a request by the Commission for any
amendment or supplement to the Registration Statement or Prospectus, or
any document incorporated by reference therein, or the receipt of any
comments from the Commission, (iii) of the initiation or threatening of
any proceedings for, or receipt by the Company of any notice with respect
to, the issuance by the Commission of any stop order suspending
effectiveness of the Registration Statement or any post-effective
amendment thereto or the issuance by any state securities commission or
other regulatory authority of any order suspending the qualification or
exemption from qualification of the Shares for the offering or sale in
any jurisdiction and (iv) during the period when the Prospectus is
required to be delivered under the Act, of any material change in the
Company's condition (financial or otherwise), business, prospects,
properties, assets, liabilities, net worth, results of operations, cash
flows or of the happening of any event that makes any statement of a
material fact made in the Registration Statement untrue or that requires
the making of any additions to or changes in the Registration Statement
in order to make the statements therein not misleading or that makes any
statement of a material fact made in the Prospectus untrue or that
requires the making of any additions to or changes in the Prospectus
required to be made therein or necessary in order to make the statements
therein, in light of the circumstances under which they were made, not
misleading. The Company will use its best efforts to prevent the issuance
of an order by the Commission at any time suspending the effectiveness of
the Registration Statement or any post-effective amendment thereto, or by
any state securities commission or other regulatory authority suspending
the qualification or exemption from qualification of the Shares and, if
any such order is issued, to obtain its withdrawal or lifting at the
earliest possible time.
(c) The Company will furnish to the Underwriters without charge
up to four signed copies of the Registration Statement (including all
exhibits and all documents incorporated by reference therein, as filed
with the Commission) and four signed copies of all amendments thereto,
and the Company will furnish without charge to those persons designated
by each Underwriter such number of conformed copies of the Registration
Statement, of each preliminary prospectus, the Prospectus and all
amendments of and supplements to such documents, if any, as such
Underwriter may reasonably request. The Company consents to the use of
the Prospectus and any amendments or supplements thereto by any
Underwriter or any dealer, both in connection with the offering or sale
of the Shares and for such period of time thereafter
<PAGE> 6
as delivery of a Prospectus is required by the Act.
(d) The Company will not file any amendment or supplement to the
Registration Statement, or any document that upon filing is deemed to be
incorporated by reference in the Registration Statement or Prospectus or
any amendment of or supplement to the Prospectus, whether before or after
the Effective Date, unless the Underwriters shall previously have been
advised thereof and shall have not objected thereto within a reasonable
time after being furnished a copy thereof. The Company shall promptly
prepare and file with the Commission, upon the Underwriters' request, any
amendment to the Registration Statement or any supplement to the
Prospectus that may be necessary or advisable in connection with the
distribution of the Shares by the Underwriters. The Company will use its
best efforts to cause any such amendment or supplement to become
effective as promptly as possible.
(e) During the time that a prospectus relating to the Shares is
required to be delivered under the Act, the Company will (i) comply with
all requirements imposed upon it by the Act and by the Regulations, as
from time to time in force, so as to permit the continuance of sales of
or dealing in the Shares as contemplated by the provisions hereof and the
Prospectus, and (ii) will file promptly all documents required to be
filed with the Commission pursuant to Section 13 or 14 of the Exchange
Act and the Exchange Act Regulations. If at any time when a prospectus
relating to the Shares is required to be delivered under the Act any
event shall have occurred as a result of which the Registration Statement
or the Prospectus as then supplemented includes an untrue statement of a
material fact or omits to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading, or if it shall
be necessary, in the judgment of the Company or in the reasonable opinion
of either counsel to the Company or counsel to the Underwriters, at any
time to amend or supplement the Registration Statement or Prospectus to
comply with the Act or the Regulations, or to file under the Exchange
Act, so as to comply therewith, any document incorporated by reference in
the Registration Statement or Prospectus or in any amendment or
supplement thereto, the Company will notify the Underwriters promptly and
prepare and file with the Commission an appropriate amendment or
supplement (in form and substance satisfactory to the Underwriters) so
that the statements in the Registration Statement and the Prospectus, as
so amended or supplemented, will not, in light of the circumstances
existing as of the date the Prospectus is so delivered, be misleading, or
so to effect such compliance with the Act or the Exchange Act and the
Regulations, and the Company will use its best efforts to cause any such
amendment to the Registration Statement to be declared effective as
promptly as possible.
(f) The Company will cooperate with the Underwriters and
Underwriters' counsel, at or prior to the time the Registration Statement
becomes effective, to qualify or register the Shares for offering and
sale and to determine the eligibility for investment of the Shares under
the securities laws of such jurisdictions as the Underwriters may
designate and to maintain such qualification or registration in effect
for so long as required for the distribution thereof; provided, however,
that the Company shall not be required in connection therewith to
register or qualify as a
<PAGE> 7
foreign corporation where it is not now so qualified or to take any action
that would subject it to service of process in suits or taxation, in each
case, other than as to matters and transactions relating to the
Registration Statement, in any jurisdiction where it is not now so
subject.
(g) The Company will make generally available (within the
meaning of Section 11(a) of the Act) to its security holders and to the
Underwriters as soon as practicable, but not later than 60 days after the
close of the period covered thereby, an earnings statement, covering a
period of at least twelve consecutive full calendar months commencing
after the effective date of the Registration Statement (but in no event
commencing later than 90 days after such date), that satisfies the
provisions of Section 11(a) of the Act and Rule 158 of the Securities Act
Regulations.
(h) The Company will apply the proceeds from the sale of the
Shares as set forth under the heading "How We Intend to Use the Proceeds
of this Offering" in the Prospectus.
(i) The Company will do and perform all things required or
necessary to be done and performed under this Agreement by it prior to
the Closing Date and to satisfy all conditions precedent on its part to
the delivery of the Shares.
(j) Prior to the Closing Date, the Company will furnish to the
Underwriters, as soon as they have been prepared in the ordinary course
by the Company, copies of any unaudited interim financial statements of
the Company, for any periods subsequent to the periods covered by the
financial statements appearing in the Registration Statement and the
Prospectus.
(k) Neither the Company nor any of its subsidiaries will take,
directly or indirectly, any action designed to, or that might reasonably
be expected to, cause or result in stabilization or manipulation of the
price of any security of the Company to facilitate the sale or resale of
the Shares. Except as permitted by the Act, the Company will not
distribute any Registration Statement, preliminary prospectus, Prospectus
or other offering material in connection with the offering and sale of
the Shares.
(l) The Company will use its best efforts to have the Shares
listed for quotation on the Nasdaq National Market concurrently with the
effectiveness of the Registration Statement.
(m) The Company will cooperate and assist in any filings
required to be made with the National Association of Securities Dealers,
Inc. ("NASD") and in the performance of any due diligence investigation
by any broker/dealer participating in the sale of the Shares.
(n) For a period of three years from Closing Date the Company
will deliver without charge to the Underwriters, promptly upon their
becoming available, copies of (i) all reports or other publicly available
information that the Company shall mail or otherwise make available to
its stockholders and (ii) all reports, financial
<PAGE> 8
statements and proxy or information statements filed by the Company with
the Commission or any national securities exchange and such other publicly
available information concerning the Company or its subsidiaries,
including without limitation, press releases.
(o) Except for (i) shares of Common Stock issuable upon exercise
of outstanding warrants of the Company or upon conversion of outstanding
convertible securities of the Company, (ii) shares of Common Stock issued
and options granted pursuant to the Stock Option Plan or (iii) shares of
Common Stock issued and options granted to newly hired management level
employees consistent with past practices of the Company, the Company will
not, directly or indirectly, sell, offer to sell, solicit an offer to
buy, contract to sell, grant any option to purchase or otherwise transfer
or dispose of or register or announce the sale or offering of any shares
of capital stock of the Company, or any securities that are convertible
into or exercisable or exchangeable for capital stock of the Company, for
a period of 120 days after the date of the Prospectus, without the prior
written consent of Bear Stearns.
(p) The Company shall cause each officer and director and each
stockholder listed on Schedule III hereto to enter into an agreement
substantially in the form set forth in Exhibit D to the effect that he,
she or it will not, for a period of 90 days after the date of the
Prospectus, offer, sell, contract to sell, grant any option to purchase
or otherwise dispose of any shares of Common Stock (or any securities
convertible into or exercisable or exchangeable for Common Stock) or
grant any options or warrants to purchase any shares of Common Stock,
without the prior written consent of Bear Stearns.
(q) The Company will comply with all the provisions of any
undertakings contained in the Registration Statement under the heading
"Where You Can Find More Information."
(r) Prior to the Closing Date or any Option Closing Date, as the
case may be, except as may be required by law, the Company will not (i)
issue any press release or other communications relating to the sale of
the Shares, or (ii) hold any press conferences with respect to the
Company or its financial condition, results of operation, business,
properties, assets or liabilities, or the sale of the Shares, without the
prior consent of the Underwriters.
7. Representations and Warranties of the Company and the Selling
Stockholders.
(1) The Company represents and warrants to each of the Underwriters
that:
(a) When the Registration Statement becomes effective, when any
post-effective amendment to the Registration Statement becomes effective,
when the Prospectus is first filed with the Commission pursuant to Rule
424(b) of the Securities Act Regulations, when any supplement to or
amendment of the Prospectus is filed with the Commission, and at the
Closing Date and during such longer period as the Prospectus may be
required to be delivered in connection with sales by the
<PAGE> 9
Underwriters or a dealer, the Registration Statement (which, as defined,
includes all documents incorporated by reference therein) and, if filed at
such time, the Prospectus (which, as defined, includes all documents
incorporated by reference therein) and any amendments thereof and
supplements thereto will comply in all material respects with the
applicable provisions of the Act, the Exchange Act and the Regulations,
and such Registration Statement did not and will not contain any untrue
statement of a material fact or omit to state any material fact required
to be stated therein or necessary in order to make the statements therein
not misleading; and such Prospectus or supplement thereto did not and will
not contain an untrue statement of a material fact or omit to state a
material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were
made, not misleading. When any related preliminary prospectus was first
filed with the Commission (whether filed as part of the Registration
Statement or an amendment thereof or pursuant to Rule 424(a) of the
Regulations) and when any amendment or supplement thereto was first filed
with the Commission, such preliminary prospectus and any amendment or
supplement thereto complied in all material respects with the applicable
provisions of the Act and the Regulations and did not contain an untrue
statement of a material fact or omit to state any material fact required
to be stated therein or necessary to make the statements therein, in light
of the circumstances under which they were made, not misleading. No
representation or warranty is made in this subsection (a), however, with
respect to any statements in or omissions from the Registration Statement
or the Prospectus or any related preliminary prospectus or any amendment
or supplement thereto based upon and conforming with information furnished
in writing by or on behalf of the Underwriters to the Company expressly
for use therein. The Company acknowledges for all purposes under this
Agreement (including Section 10 hereof) that the statements set forth in
the last paragraph on the cover page of the Prospectus and in the third
paragraph below the first table under the caption "Underwriting" in the
Prospectus and the last four paragraphs of the section under the caption
"Underwriting" in the Prospectus constitute the only written information
furnished to the Company by the Underwriters for use in the Prospectus or
any preliminary prospectus (or any amendments or supplements thereto).
(b) The Company and the transactions contemplated by this
Agreement meet the requirements for using Form S-3 under the Act. The
documents incorporated by reference in the Registration Statement, the
Prospectus, any amendment or supplement thereto or any preliminary
prospectus and any further documents incorporated by reference, when they
became or become effective under the Act or were or are filed with the
Commission under the Exchange Act, as the case may be, conformed or will
conform in all material respects with the requirements of the Act or the
Exchange Act, as applicable, and the Regulations; no such document when
it was or is filed (or, if an amendment with respect to any such document
was or is filed, when such amendment was filed), contained an untrue
statement of a material fact or omitted to state a material fact required
to be stated therein or necessary in order to make the statements therein
not misleading. Each preliminary prospectus and Prospectus filed as part
of the Registration Statement, as part of any amendment thereto or
pursuant to Rule 424 under the Securities Act Regulations, if filed by
electronic transmission pursuant to Regulation S-T under the Securities
Act, was identical to the
<PAGE> 10
copy thereof delivered to the Underwriters for use in connection with the
offer and sales of the Shares (except as may be permitted by Regulation
S-T under the Securities Act).
(c) There are no contracts or documents of the Company or any of
its subsidiaries that are required to be filed as exhibits to the
Registration Statement or to any of the documents incorporated by
reference therein by the Act, the Exchange Act or by the Regulations that
have not been so filed.
(d) No stop order suspending the effectiveness of the
Registration Statement or preventing or suspending the use of any
preliminary prospectus has been issued and no proceedings for that
purpose have been commenced or are pending before or, to the best
knowledge of the Company, are contemplated by the Commission. No stop
order suspending the sale of the Shares in any jurisdiction designated by
the Underwriters has been issued and no proceedings for that purpose have
been commenced or are pending or, to the best knowledge of the Company,
are contemplated.
(e) Each of the Company and its subsidiaries (A) has been duly
organized and is validly existing as a corporation in good standing under
the laws of its respective jurisdiction of incorporation, (B) has all
requisite corporate power and authority to carry on its business as it is
currently being conducted and as described in the Registration Statement
and the Prospectus and to own, lease and operate its properties, and (C)
is duly qualified and in good standing as a foreign corporation
authorized to do business in each jurisdiction in which the nature of its
business or its ownership or leasing of property requires such
qualification except, with respect to this clause (C), where the failure
to be so qualified or in good standing does not and could not reasonably
be expected to (x) individually or in the aggregate, result in a material
adverse effect on the properties, business, results of operations,
condition (financial or otherwise), affairs or prospects of the Company
and its subsidiaries, taken as a whole, (y) interfere with or adversely
affect the issuance or marketability of the Shares pursuant hereto or (z)
in any manner draw into question the validity of this Agreement (any of
the events set forth in clauses (x), (y) or (z), a "Material Adverse
Effect"). All of the issued and outstanding shares of capital stock of,
or other ownership interests in, each subsidiary have been duly
authorized and validly issued, and are fully paid and non-assessable and
were not issued in violation of or subject to any preemptive or similar
rights and are owned by the Company directly, free and clear of any
security interest, mortgage, pledge, lien, encumbrance, claim or other
restriction on transferability or voting. Except for the capital stock of
the subsidiaries owned by the Company, neither the Company nor any of its
subsidiaries owns or holds any interest in any corporation partnership,
trust or association, joint venture or other entity.
(f) The authorized capital stock of the Company immediately
prior to the Closing Date will consist of the following: (i) 60,000,000
shares of Common Stock, of which [17,505,050] shares will be issued and
outstanding immediately prior to the Closing Date (other than Common
Stock issued upon exercise of options or warrants currently outstanding
or conversion of the Series B Preferred Stock (as defined below))
<PAGE> 11
and (ii) 50,000,000 shares of preferred stock, of which 5,278,000 have
been designated as Series B Convertible Preferred Stock (the "Series B
Preferred Stock"), and of which 5,277,779 shares of the Series B Preferred
Stock will be issued and outstanding immediately prior to the Closing Date
(except to the extent any shares of Series B Preferred Stock are converted
into Common Stock). All of the outstanding shares of capital stock of the
Company and each subsidiary have been duly authorized, validly issued, and
are fully paid and nonassessable and were not issued in violation of any
preemptive or similar rights. Except as set forth in the Prospectus, there
are no outstanding subscriptions, rights, warrants, calls, commitments of
sale or options to acquire (other than options issued during the period
commencing on the date hereof and ending on the Closing Date or the Option
Closing Date, as the case may be, pursuant to the Stock Option Plan in
accordance with the third paragraph of Section 3 of this Agreement), or
instruments convertible or exchangeable or exercisable for, any capital
stock or other equity interest in the Company or its subsidiaries. The
Shares have been duly authorized and, when the Company Shares are issued
and delivered to the Underwriters against payment therefor in accordance
with the terms hereof, the Shares will be validly issued, fully paid and
nonassessable and free of any preemptive or similar rights. The authorized
capital stock of the Company conforms in all respects to the description
thereof in the Registration Statement and the Prospectus. All of the
Company's subsidiaries are listed in Section 2 hereof. The authorized
capital stock of (i) MGC Lease Corporation consists of 5,000 shares of
common stock, $.10 par value per share, all of which are issued to, and
owned of record and beneficially by, the Company, (ii) MGC LJ.Net, Inc.
consists of 10,000 shares of common stock, $.01 par value per share, of
which 100 are issued and outstanding, all of which are issued to, and
owned of record and beneficially by, the Company, and (iii) MGC License
Corporation consists of 10,000 shares of common stock, $.01 par value per
share, of which 100 shares are issued and outstanding, all of which are
issued to, and owned of record and beneficially by, the Company.
(g) The Company has all requisite corporate power and authority
to execute, deliver and perform its obligations under this Agreement, and
to consummate the transactions contemplated hereby, including, without
limitation, the corporate power and authority to issue, sell and deliver
the Company Shares as provided herein.
(h) This Agreement has been duly and validly authorized,
executed and delivered by the Company and is the legal, valid and binding
agreement of the Company, enforceable against it in accordance with its
terms, except insofar as indemnification and contribution provisions may
be limited by applicable law or equitable principles and subject to
applicable bankruptcy, insolvency, fraudulent conveyance, reorganization
or similar laws affecting the rights of creditors generally and subject
to general principles of equity.
(i) None of the Company or any of the subsidiaries is (A) in
violation of its charter or bylaws, (B) in default in the performance of
any bond, debenture, note, indenture, mortgage, deed of trust or other
agreement or instrument to which it is a party or by which it is bound or
to which any of its properties is subject, or (C) in violation of any
local, state or Federal law, statute, ordinance, rule, regulation,
<PAGE> 12
requirement, judgment or court decree (including, without limitation, the
Communications Act of 1934, as amended by the Telecommunications Act of
1996 and the rules and regulations of the Federal Communications
Commission (the "FCC") and environmental laws, statutes, ordinances,
rules, regulations, judgments or court decrees) applicable to the Company
or any subsidiary or any of their assets or properties (whether owned or
leased) other than, in the case of clauses (B) and (C), any default or
violation that could not reasonably be expected to have a Material Adverse
Effect. There exists no condition that, with notice, the passage of time
or otherwise, would constitute a default under any such document or
instrument.
(j) None of (A) the execution, delivery or performance by the
Company of this Agreement; (B) the issuance of the Company Shares; and
(C) the sale of the Shares will violate, conflict with or constitute a
breach of any of the terms or provisions of, or a default under (or an
event that with notice or the lapse of time, or both, would constitute a
default), or require consent under, or result in the imposition of a lien
or encumbrance on any properties of the Company or any subsidiary, or an
acceleration of any indebtedness of the Company or any subsidiary
pursuant to, (i) the charter or bylaws of the Company or any subsidiary,
(ii) any bond, debenture, note, indenture, mortgage, deed of trust or
other agreement or instrument to which the Company or any subsidiary is a
party or by which any of them or their property is or may be bound, (iii)
any statute, rule or regulation applicable to the Company or any
subsidiary or any of their respective assets or properties or (iv) any
judgment, order or decree of any court or governmental agency or
authority having jurisdiction over the Company or the subsidiaries or any
of their assets or properties, except that the Company has not received
written approval from the Georgia Public Service Commission as to the
sale of the Shares and except in the case of clauses (ii), (iii) and (iv)
for such violations conflicts, breaches, defaults, consents, impositions
of liens or accelerations that would not singly, or in the aggregate,
have a Material Adverse Effect. Other than as described in the
Prospectus, no consent, approval, authorization or order of, or filing,
registration, qualification, license or permit of or with, (A) any court
or governmental agency, body or administrative agency (including, without
limitation, the FCC) or (B) any other person is required for (1) the
execution, delivery and performance by the Company of this Agreement, (2)
the issuance of the Company Shares, and (3) the sale of the Shares and
the consummation of the transactions contemplated hereby or by the
Prospectus, except (x) such as have been obtained and made under the Act
and state securities or Blue Sky laws and regulations or such as may be
required by the NASD or (y) where the failure to obtain any such consent,
approval, authorization or order of, or filing registration,
qualification, license or permit would not reasonably be expected to
result in a Material Adverse Effect.
(k) Except as set forth in the Prospectus, there is (i) no
action, suit, investigation or proceeding before or by any court,
arbitrator or governmental agency, body or official, domestic or foreign,
now pending or, to the best knowledge of the Company or any subsidiary,
threatened or contemplated to which the Company or any of its
subsidiaries is or may be a party or to which the business or property of
the Company or any of its subsidiaries is or may be subject, (ii) no
statute, rule, regulation or order that has been enacted, adopted or
issued by any governmental agency or that
<PAGE> 13
has been proposed by any governmental body and (iii) no injunction,
restraining order or order of any nature by a federal or state court or
foreign court of competent jurisdiction to which the Company or any
subsidiary is or may be subject or to which the business, assets, or
property of the Company or any subsidiary are or may be subject, that, in
the case of clauses (i), (ii) and (iii) above, (x) is required to be
disclosed in the Registration Statement or the Prospectus, (y) could
reasonably be expected to, individually or in the aggregate, result in a
Material Adverse Effect or (z) might interfere with, adversely affect or
in any manner question the validity of the issuance and sale of the Shares
or any of the other transactions contemplated by this Agreement and the
Registration Statement.
(l) There is (i) no significant unfair labor practice complaint
pending against the Company or any subsidiary nor, to the best knowledge
of the Company, threatened against any of them, before the National Labor
Relations Board, any state or local labor relations board or any foreign
labor relations board, and no significant grievance or significant
arbitration proceeding arising out of or under any collective bargaining
agreement is so pending against the Company or any subsidiary or, to the
best knowledge of the Company, threatened against any of them, (ii) no
significant strike, labor dispute, slowdown or stoppage pending against
the Company or any subsidiary nor, to the best knowledge of the Company,
threatened against the Company or any subsidiary and (iii) to the best
knowledge of the Company, no union representation question existing with
respect to the employees of the Company or any subsidiary that, in the
case of clauses (i), (ii) or (iii), could reasonably be expected to
result in a Material Adverse Effect. To the best knowledge of the
Company, no collective bargaining organizing activities are taking place
with respect to the Company or any subsidiary. None of the Company or any
subsidiary has violated (A) any federal, state or local law or foreign
law relating to discrimination in hiring, promotion or pay of employees
(except as set forth in the Registration Statement), (B) any applicable
wage or hour laws or (C) any provision of the Employee Retirement Income
Security Act of 1974, as amended ("ERISA"), or the rules and regulations
thereunder, which in the case of clause (A), (B) or (C) above could
reasonably be expected to result in a Material Adverse Effect.
(m) No employee pension benefit plan (within the meaning of
Section 3(2) of ERISA, but excluding any "multiemployer plan" within the
meaning of Section 3(37) of ERISA) established or maintained by the
Company or any subsidiary or to which the Company or any subsidiary has
made contributions, which is subject to Part 3 or Subtitle B of Title I
of ERISA, or Section 412 of the Internal Revenue Code of 1986 (the
"Code"), had an accumulated funding deficiency (as such term is defined
in Section 302 of ERISA or Section 412 of the Code), whether or not
waived, as of the last day of the most recent plan year of such plan
heretofore ended for which an excise tax is due (or would be due if such
deficiency were not waived). Each of the Company and the subsidiaries has
made all contributions required to be made by it to any "multiemployer
pension plan" (within the meaning of Section 3(37) of ERISA). Neither the
Company nor any subsidiary nor any Related Person (as such term is
defined below) has incurred, or is expecting to incur, any withdrawal
liability (determined under Section 4201 of ERISA) with respect to any
plan covered by Title
<PAGE> 14
IV of ERISA and in respect of which the Company or any subsidiary or a
Related Person is an "employer" as defined in Section 3(5) of ERISA, and
to the best of the Company's knowledge, there has not been any "reportable
event" (within the meaning of Section 4043 of ERISA and regulations
thereunder, other than an event for which the 30-day notice requirement
has been waived), or any other event or condition which presents a
material risk of the termination of any such plan, including, but not
limited to, a termination by action of the Pension Benefit Guaranty
Corporation, which termination would create a material liability of the
Company or any subsidiary or a Related Person to the Pension Benefit
Guaranty Corporation. "Related Person" shall mean any trade or business
(whether or not incorporated) which is under common control (as defined in
Section 414(b) and (c) of the Code) with the Company within the meaning of
Section 4001(b) of ERISA. As of the last day of the most recent plan year
heretofore ended of each employee benefit plan described in the preceding
sentence (other than a "multiemployer plan"), the present value of all
accrued benefits under each such employee benefit plan (calculated on the
basis of the actuarial assumptions specified in the most recent actuarial
valuation for each such plan) did not exceed the fair market value of the
assets of such plan allocable to such benefits by more than $1,000,000.
Neither any employee pension benefit plan (excluding any "multiemployer
plan" within the meaning of Section 3(37) of ERISA) established or
maintained by the Company or any subsidiary or to which the Company or any
subsidiary has made contributions, nor any trust created thereunder, nor
any trustee or administrator thereof (including the Company), has engaged
in any non-exempt prohibited transaction (as described in Section 406 of
ERISA or in Section 4975 of the Code) that could subject the Company or
any subsidiary either directly or indirectly through an obligation to
indemnify to any material tax or material penalty on prohibited
transactions imposed under said Section 4975 of the Code or under ERISA.
Each employee benefit plan described in the preceding sentence is in
compliance in all material respects with all applicable provisions of
ERISA and the Code, except for plan amendments required or permitted by
such statutes as to which applicable grace periods for making such
amendments have not expired, and each of the Company and the subsidiaries
has made, accrued or provided for all contributions heretofore required to
be made by the Company and the subsidiaries and each of the Company and
the subsidiaries has complied in all material respects with the
continuation coverage requirements of Title X of the Consolidated Omnibus
Budget Act of 1985, as amended. The execution and delivery of this
Agreement and the sale of the Shares will not involve any prohibited
transaction within the meaning of Section 406 of ERISA or Section 4975 of
the Code. Neither the Company nor any subsidiary has any material
"expected post-retirement benefit obligation" (within the meaning of
Financial Accounting Standards Board Statement No. 106). The consummation
of the transactions contemplated by this Agreement (including, without
limitation, the provisions of the Prospectus described under the heading
"How We Intend to Use the Proceeds of this Offering") will not result in
any material payment (including, without limitation, severance, golden
parachute or other) becoming due from the Company to any employee of the
Company or any of its subsidiaries as a consequence of such transaction.
(n) None of the Company or any subsidiary has violated any
<PAGE> 15
environmental, safety or similar law or regulation applicable to it or its
business or property relating to the protection of human health and
safety, the environment or hazardous or toxic substances or wastes,
pollutants or contaminants ("Environmental Laws"), lacks any permit,
license or other approval required of it under applicable Environmental
Laws or is violating any term or condition of such permit, license or
approval which could reasonably be expected to, either individually or in
the aggregate, have a Material Adverse Effect. No facilities owned or
leased by the Company or any subsidiary, or to the best knowledge of the
Company, any facilities of any predecessor in interest of the Company or
any subsidiary, is listed or, to the best knowledge of the Company,
formally proposed for listing on the National Priorities List or the
Comprehensive Environmental Response, Compensation, and Liability
Information System, both as promulgated under the Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA"), or on
any comparable state list, or comparable local list, and the Company has
not received any written notification of potential or actual liability, or
any written request for information, pursuant to CERCLA or any comparable
state, local or foreign environmental law.
(o) Each of the Company and the subsidiaries has (i) good and
marketable title to all of the properties and assets described in the
Prospectus as owned by it, free and clear of all liens, charges,
encumbrances and restrictions, except such as are described in the
Registration Statement or as would not have a Material Adverse Effect,
(ii) peaceful and undisturbed possession under all material leases to
which any of them is a party as lessee, (iii) all licenses, certificates,
permits, authorizations, approvals, franchises and other rights from, and
has made all declarations and filings with, all federal, state and local
authorities (including, without limitation, the FCC), all self-regulatory
authorities and all courts and other tribunals (each an "Authorization")
necessary to engage in the business conducted by any of them in the
manner described in the Prospectus, except as described in the Prospectus
or where failure to hold such Authorizations would not, individually or
in the aggregate, have a Material Adverse Effect and, (iv) no reason to
believe that any governmental body or agency is considering limiting,
suspending or revoking any such Authorization. Except where the failure
to be in full force and effect would not have a Material Adverse Effect,
all such Authorizations are valid and in full force and effect and each
of the Company and the subsidiaries is in compliance in all material
respects with the terms and conditions of all such Authorizations and
with the rules and regulations of the regulatory authorities having
jurisdiction with respect thereto. All material leases to which the
Company or any subsidiary is a party are valid and binding and no default
by the Company or any subsidiary has occurred and is continuing
thereunder and, to the best knowledge of the Company and the subsidiaries
no material defaults by the landlord are existing under any such lease
that could reasonably be expected to result in a Material Adverse Effect.
(p) Each of the Company and the subsidiaries owns, possesses or
has the right to employ all patents, patent rights, licenses (including
all FCC, state, local or other jurisdictional regulatory licenses),
inventions, copyrights, know-how (including trade secrets and other
unpatented and/or unpatentable proprietary or confidential information,
software, systems or procedures), trademarks, service marks and trade
<PAGE> 16
names, inventions, computer programs, technical data and information
(collectively, the "Intellectual Property") presently employed by it or
its subsidiaries in connection with the businesses now operated by it or
which are proposed to be operated by it or its subsidiaries free and clear
of and without violating any right, claimed right, charge, encumbrance,
pledge, security interest, restriction or lien of any kind of any other
person and none of the Company or any subsidiary has received any notice
of infringement of or conflict with asserted rights of others with respect
to any of the foregoing except as could not reasonably be expected to have
a Material Adverse Effect. The use of the Intellectual Property in
connection with the business and operations of the Company and the
subsidiaries does not infringe on the rights of any person, except as
could not reasonably be expected to have a Material Adverse Effect.
(q) None of the Company or any subsidiary, or to the best
knowledge of the Company, any of their respective officers, directors,
partners, employees, agents or affiliates or any other person acting on
behalf of the Company or any subsidiary has, directly or indirectly,
given or agreed to give any money, gift or similar benefit (other than
legal price concessions to customers in the ordinary course of business)
to any customer, supplier, employee or agent of a customer or supplier,
official or employee of any governmental agency (domestic or foreign),
instrumentality of any government (domestic or foreign) or any political
party or candidate for office (domestic or foreign) or other person who
was, is or may be in a position to help or hinder the business of the
Company or any subsidiary (or assist the Company or any subsidiary in
connection with any actual or proposed transaction) which (i) might
subject the Company or any subsidiary, or any other individual or entity
to any damage or penalty in any civil, criminal or governmental
litigation or proceeding (domestic or foreign), (ii) if not given in the
past, might have had a Material Adverse Effect or (iii) if not continued
in the future, might have a Material Adverse Effect.
(r) All material tax returns required to be filed by the Company
and each of the subsidiaries in all jurisdictions have been so filed. All
taxes, including withholding taxes, penalties and interest, assessments,
fees and other charges due or claimed to be due from such entities or
that are due and payable have been paid, other than those being contested
in good faith and for which adequate reserves have been provided or those
currently payable without penalty or interest. To the best knowledge of
the Company, there are no material proposed additional tax assessments
against the Company, any subsidiary or the assets or property of the
Company or any subsidiary.
(s) None of the Company or the subsidiaries is (i) an
"investment company" or a company "controlled" by an "investment company"
within the meaning of the Investment Company Act of 1940, as amended, or
(ii) a "holding company" or a "subsidiary company" or an "affiliate" of a
holding company within the meaning of the Public Utility Holding Company
Act of 1935, as amended.
(t) Except for the Shares sold by the Selling Stockholders, no
holders of any securities of the Company or of any subsidiary or their
respective affiliates or of any options, warrants or other convertible or
exchangeable securities of the Company or any subsidiary or their
respective affiliates are entitled to include any such securities
<PAGE> 17
in or to have such securities registered under the Registration Statement.
(u) Each of the Company and the subsidiaries maintains a system
of internal accounting controls sufficient to provide reasonable
assurance that: (i) transactions are executed in accordance with
management's general or specific authorizations; (ii) transactions are
recorded as necessary to permit preparation of financial statements in
conformity with generally accepted accounting principles and to maintain
accountability for assets; (iii) access to assets is permitted only in
accordance with management's general or specific authorization and (iv)
the recorded accountability for assets is compared with the existing
assets at reasonable intervals and appropriate action is taken with
respect thereto.
(v) Each of the Company and the subsidiaries maintains insurance
covering its properties, operations, personnel and businesses. Such
insurance insures against such losses and risks as are adequate in
accordance with customary industry practice to protect the Company and
the subsidiaries and their respective businesses. None of the Company or
any subsidiary has received notice from any insurer or agent of such
insurer that substantial capital improvements or other expenditures will
have to be made in order to continue such insurance. All such insurance
is outstanding and duly in force on the date hereof, subject only to
changes made in the ordinary course of business, consistent with past
practice, which do not, singly or in the aggregate, materially alter the
coverage thereunder or the risks covered thereby.
(w) None of the Company or any of its subsidiaries has taken,
directly or indirectly, any action designed to, or that might reasonably
be expected to, cause or result in stabilization or manipulation of the
price of any security of the Company to facilitate the sale or resale of
the Shares. Except as permitted by the Act, the Company has not
distributed any Registration Statement, preliminary prospectus,
Prospectus or other offering material in connection with the offering and
sale of the Shares.
(x) Subsequent to the respective dates as of which information
is given in the Registration Statement and up to the Closing Date, except
as set forth in the Registration Statement, there has not been and there
shall not be any material adverse change in the business, prospects,
properties, assets, liabilities, operations, condition (financial or
otherwise), results of operations or cash flows of the Company and its
subsidiaries, taken as a whole, whether or not arising from transactions
in the ordinary course of business, and since the date of the latest
balance sheet included in the Registration Statement, neither the Company
nor any of its subsidiaries has incurred or undertaken any liabilities or
obligations, direct or contingent, which are material to the Company and
its subsidiaries, taken as a whole, except for liabilities or obligations
which were incurred or undertaken in the ordinary course of business or
are reflected in the Registration Statement and the Prospectus.
Subsequent to the dates as of which information is given in the
Registration Statement and the Prospectus, except as disclosed therein,
there has not been any decrease in the capital stock of the Company, any
increase in long-term indebtedness or any material increase in short-term
indebtedness of the Company or any of its subsidiaries or any payment or
declaration to pay any dividends or any other distribution with respect
to the capital stock of the
<PAGE> 18
Company.
(y) To the best knowledge of the Company, KPMG LLC and Arthur
Andersen LLP, whose reports are included or incorporated by reference in
the Registration Statement, are or have been independent certified public
accountants with regard to the Company as required by the Act and the
Securities Act Regulations.
(z) The consolidated financial statements of the Company and
its subsidiaries and the related notes and schedules included in the
Registration Statement and the Prospectus comply in all material respects
with the requirements of the Act and the Securities Act Regulations,
including, without limitation, Regulation S-X, and present fairly the
financial position of the Company and its subsidiaries as of the dates
indicated and the results of operations and cash flows of the Company and
its subsidiaries for the periods therein specified. Such consolidated
financial statements (including the related notes and schedules) have
been prepared in accordance with generally accepted accounting principles
applied on a consistent basis throughout the periods therein specified,
subject in the case of interim statements to normal year-end audit
adjustments. Since the date of the latest of such consolidated financial
statements, except as disclosed in the Prospectus, there has been no
material adverse change in the financial position, results of operations
or business of the Company and its subsidiaries, taken as a whole.
(aa) The financial information of the Company and its
subsidiaries set forth in the Prospectus under the captions "Prospectus
Summary -- Summary Consolidated Financial and Operating Data,"
"Dilution," "Capitalization," "Selected Consolidated Financial and
Operating Data," and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" has been fairly stated in all
material respects in relation to the relevant financial statements of the
Company and its subsidiaries and from which such information has been
derived.
(bb) The as adjusted financial information and the related notes
thereto included in the Registration Statement have been prepared in
accordance with the Commission's rules and guidelines with respect to as
adjusted financial statements, have been properly compiled on the as
adjusted basis described therein and, in the opinion of the Company, the
assumptions used in the preparation thereof are reasonable and the
adjustments used therein are appropriate to give effect to the
transactions and circumstances referred to therein.
(cc) Except pursuant to this Agreement, there are no contracts,
agreements or understandings between the Company and any other person
that would give rise to a valid claim against the Company or any of the
Underwriters for a brokerage commission, finder's fee or like payment in
connection with the issuance, purchase and sale of the Company Shares.
(dd) Each certificate signed by any officer of the Company and
delivered to the Underwriters or counsel for the Underwriters shall be
deemed to be a representation and warranty by the Company to the
Underwriters as to the matters
<PAGE> 19
covered thereby.
(ee) Each of the Shares and this Agreement, as or when executed
and delivered, will conform in all material respects to the descriptions
thereof contained in the Registration Statement and the Prospectus.
(ff) The Company has complied with all of its obligations to the
Selling Stockholders as set forth in (i) the Warrant Registration Rights
Agreement, dated as of September 29, 1997, by and among the Company, Bear
Stearns and Furman Selz LLC (the "Warrant Agreement"), (ii) the
Stockholders Agreement, dated as of November 26, 1997, by and among the
Company and the persons listed therein (the "Series A Agreement"), (iii)
the Series B Preferred Stock Registration Rights Agreement, dated as of
May 4, 1999, by and among the Company and the persons listed therein (the
"Series B Agreement"), and (iv) the Agreement and Plan of Merger, dated
as of March 15, 1999, by and among the Company, LJ.Net, Inc., MGC LJ.Net,
Inc., Patrick Chicas and James Thompson (the "Merger Agreement").
(gg) Each holder of five percent or more of the total issued and
outstanding capital stock of the Company (assuming conversion of all
outstanding shares of the Series B Preferred Stock) is listed on Schedule
III to this Agreement.
(2) Each Selling Stockholder severally represents and warrants to the
Underwriters and the Company that:
(a) Such Selling Stockholder is the lawful owner of the Shares
to be sold by such Selling Stockholder pursuant to this Agreement and
has, and on the Closing Date will have, good and clear title to such
Shares, free of all restrictions on transfer, liens, encumbrances,
security interests and claims whatsoever.
(b) Upon delivery of and payment for such Shares pursuant to
this Agreement, good and clear title to such Shares will pass to the
Underwriters, free of all restrictions on transfer, liens, encumbrances,
security interests and claims whatsoever.
(c) Such Selling Stockholder has no reason to believe that the
representations and warranties of the Company contained in this Section 7
are not true and correct, is familiar with the Registration Statement and
has no knowledge of any material fact, condition or information not
disclosed in the Prospectus or any supplement thereto which has adversely
affected or may adversely affect the business of the Company or any of
its subsidiaries; and the sale of Shares by such Selling Stockholder
pursuant hereto is not prompted by any information concerning the Company
or any of its subsidiaries which is not set forth in the Prospectus or
any supplement thereto.
(d) If such Selling Stockholder is a corporation, such Selling
Stockholder has been duly incorporated and is an existing corporation in
good standing under the laws of its jurisdiction of incorporation.
<PAGE> 20
(e) Such Selling Stockholder has, and on the Closing Date will
have, full legal right, power and authority to enter into this Agreement
and the Custody Agreement (the "Custody Agreement") between the Selling
Stockholders and MGC Communications, Inc., as Custodian (the "Custodian")
and to sell, assign, transfer and deliver such Shares in the manner
provided herein and therein, and this Agreement and the Custody Agreement
have been duly authorized, executed and delivered by such Selling
Stockholder and each of this Agreement and the Custody Agreement is a
valid and binding agreement of such Selling Stockholder enforceable in
accordance with its terms, except insofar as indemnification and
contribution provisions may be limited by applicable law or equitable
principles and subject to applicable bankruptcy, insolvency, fraudulent
conveyance, reorganization or similar laws affecting the rights of
creditors generally and subject to general principles of equity.
Certificates in negotiable form representing the Shares to be sold by the
Selling Stockholders as provided herein have been placed in custody under
the terms of the Custody Agreement for delivery pursuant to the terms
hereof.
(f) The power of attorney signed by such Selling Stockholder
appointing David S. Clark and Linda M. Sunbury, or either of them, as its
attorney-in-fact to the extent set forth therein with regard to the
transactions contemplated hereby and by the Registration Statement and
the Custody Agreement has been duly authorized, executed and delivered by
or on behalf of such Selling Stockholder and is a valid and binding
instrument of such Selling Stockholder enforceable in accordance with its
terms and, pursuant to such power of attorney, such Selling Stockholder
has authorized David S. Clark and Linda M. Sunbury, or either of them, to
execute and deliver on its behalf this Agreement and any other document
necessary or desirable in connection with the transactions contemplated
hereby and to deliver the Shares to be sold by such Selling Stockholder
pursuant to this Agreement.
(g) Such Selling Stockholder has not taken, and will not take,
directly or indirectly, any action designed to, or which might reasonably
be expected to, cause or result in stabilization or manipulation of the
price of any security of the Company to facilitate the sale or resale of
the Shares pursuant to the distribution contemplated by this Agreement,
and other than as permitted by the Act, the Selling Stockholder has not
distributed and will not distribute any prospectus or other offering
material in connection with the offering and sale of the Shares.
(h) The execution, delivery and performance of this Agreement
by such Selling Stockholder, compliance by such Selling Stockholder with
all the provisions hereof and the consummation of the transactions
contemplated hereby will not require any consent, approval, authorization
or other order of any court, regulatory body, administrative agency or
other governmental body (except as such may be required under the Act,
state securities laws or Blue Sky laws) and will not conflict with or
constitute a breach of any of the terms or provisions of, or a default
under, organizational documents of such Selling Stockholder, if not an
individual, or any agreement, indenture or other instrument to which such
Selling Stockholder is a party or by which such Selling Stockholder or
property of such Selling Stockholder is bound, or violate or conflict
with any laws, administrative regulation or ruling or court decree
<PAGE> 21
applicable to such Selling Stockholder or property of such Selling
Stockholder.
(i) Such parts of the Registration Statement, comprised of the
table and notes thereto under the caption "Selling Stockholders" which
specifically relate to such Selling Stockholder do not, and will not on
the Closing Date, contain any untrue statement of a material fact or omit
to state any material fact required to be stated therein or necessary to
make the statements therein, in light of circumstances under which they
were made, not misleading.
(j) At any time during the period described in paragraph 6(e)
hereof, if there is any change in the information referred to in the
above paragraph, the Selling Stockholders will immediately notify Bear
Stearns of such change.
(k) Each certificate signed by or on behalf of any Selling
Stockholder and delivered to the Underwriters or counsel for the
Underwriters shall be deemed to be a representation and warranty by such
Selling Stockholder to the Underwriters as to the matters covered
thereby.
The Company and the Selling Stockholders acknowledge that each of
the Underwriters and, for purposes of the opinions to be delivered to the
Underwriters pursuant to Section 10 hereof, counsel to the Company, counsel to
each Selling Stockholder and counsel to the Underwriters, will rely upon the
accuracy and truth of the foregoing representations and hereby consents to such
reliance.
8. Payment of Expenses. Whether or not the transactions contemplated
in this Agreement are consummated or this Agreement becomes effective or is
terminated, the Company agrees to pay and be responsible for all costs,
expenses, fees and taxes related to the following matters: (i) preparing,
printing, duplicating, filing and distributing the Registration Statement, as
originally filed and all amendments thereto (including, without limitation,
financial statements and all exhibits thereto), each preliminary prospectus,
the Prospectus and any amendments thereof or supplements thereto, the
underwriting documents (including this Agreement) and all other documents
related to the public offering of the Shares (including those supplied to the
Underwriters in quantities as hereinabove stated); (ii) the preparation
(including, without limitation, duplication costs) and delivery of all
preliminary and final Blue Sky memoranda prepared and delivered in connection
herewith; (iii) the registration with the Commission and the Nasdaq National
Market (including all filing fees incident thereto) and the issuance, transfer
and delivery of the Shares to the Underwriters, including, without limitation,
the fees of the transfer agent and registrar for the Company, the cost of its
personnel and other internal costs, the costs of printing and engraving the
certificates representing the Shares and any transfer or other taxes payable in
connection with the original issuance and sale of the Company Shares; (iv) the
qualification or registration of the Shares for offering and sale under state
and foreign securities or Blue Sky laws, including, without limitation, the
costs of printing and mailing preliminary and final Blue Sky memoranda and the
reasonable fees and disbursements of Underwriters' counsel in relation thereto;
(v) the fees, disbursements and expenses of the Company's counsel and
accountants; (vi) the filing, registration, review and clearance of the terms
of the public offering of the Shares with and by the NASD including, in each
case, any filing fees and fees and disbursements of Underwriters' counsel in
connection
<PAGE> 22
therewith; (vii) all other fees, costs and expenses incident to the performance
of the obligations of the Company hereunder; (viii) all fees, costs and expenses
of the Selling Stockholders which are not specifically designated as expenses to
be paid by the Selling Stockholders under the terms of the Warrant Agreement,
the Series A Agreement, the Series B Agreement or the Merger Agreement; and (ix)
"roadshow" travel and other expenses incurred in connection with the marketing
and sale of the Shares (other than out-of-pocket expenses incurred by the
Underwriters for travel, meals and lodging).
9. Conditions of Underwriters' Obligations. The several obligations of
the Underwriters to purchase and pay for the Firm Shares and the Additional
Shares, as provided herein, shall be subject to the absence from any
certificates, opinions, written statements or letters furnished pursuant to
this Section 9 to the Underwriters or to Underwriters' counsel of any
misstatement or omission and to the satisfaction of each of the following
additional conditions, except that with respect to the Additional Shares,
references to the Closing Date shall mean the Option Closing Date:
(a) All of the representations and warranties of the Company
contained herein shall be true and correct on the date hereof and on the
Closing Date with the same force and effect as if made on and as of the
date hereof and the Closing Date, respectively. The Company shall have
performed or complied with all of the agreements herein contained and
required to be performed or complied with by it at or prior to the
Closing Date.
(b) The Registration Statement shall have become effective (or
if a post-effective amendment is required to be filed pursuant to Rule
430A under the Securities Act Regulations, such post effective amendment
shall become effective) not later than 5:00 P.M., New York City time, on
the date of this Agreement or at such later time and date as shall have
been consented to in writing by the Underwriters. At or prior to the
Closing Date no stop order suspending the effectiveness of the
Registration Statement or any post-effective amendment thereof shall have
been issued and no proceedings therefor shall have been initiated or
threatened by the Commission, and every request for additional
information on the part of the Commission (including, without limitation,
any request or comment with respect to the Registration Statement, the
Prospectus or any document incorporated by reference therein) shall have
been complied with in all material respects. No stop order suspending the
sale of the Shares in any jurisdiction designated by the Underwriters
shall have been issued and no proceedings for that purpose shall have
been commenced or be pending or, to the best knowledge of the Company, be
contemplated.
(c) No action shall have been taken and no statute, rule,
regulation or order shall have been enacted, adopted or issued by any
governmental agency which would, as of the Closing Date, prevent the
issuance of the Company Shares; and no action, suit or proceeding shall
have been commenced and be pending against or affecting or, to the best
knowledge of the Company, threatened against, the Company or any
subsidiary before any court or arbitrator or any governmental body,
agency or official that, if adversely determined, could reasonably be
expected to result in a Material Adverse Effect.
<PAGE> 23
(d) Since the date of the latest balance sheet included in the
Registration Statement and the Prospectus, and except as disclosed in the
Registration Statement or contemplated thereby, (i) there shall not have
been any material adverse change, or any development that is reasonably
likely to result in a material adverse change, in the capital stock or
the long-term debt, or material increase in the short-term debt, of the
Company and the subsidiaries from that set forth in the Registration
Statement and the Prospectus, (ii) no dividend or distribution of any
kind shall have been declared, paid or made by the Company or any
subsidiary on any class of its capital stock and (iii) neither the
Company nor any subsidiary shall have incurred any liabilities or
obligations, direct or contingent, that are material, individually or in
the aggregate, to the Company and the subsidiaries, taken as a whole, and
that are required to be disclosed on a balance sheet or notes thereto in
accordance with generally accepted accounting principles and are not
disclosed on the latest balance sheet or notes thereto included in the
Registration Statement and the Prospectus. Since the date hereof and
since the dates as of which information is given in the Registration
Statement and the Prospectus, there shall not have occurred any Material
Adverse Effect.
(e) The Underwriters shall have received a certificate, dated
the Closing Date, signed on behalf of the Company by (i) Nield J.
Montgomery, President and Chief Executive Officer and (ii) Linda M.
Sunbury, Senior Vice President and Chief Financial Officer of the Company
in form and substance reasonably satisfactory to the Underwriters,
confirming, as of the Closing Date, the matters set forth in paragraphs
(a), (b), (c) and (d) of this Section 9 and that, as of the Closing Date,
the obligations of the Company to be performed hereunder on or prior
thereto have been duly performed and stating that each signer of such
certificate has examined the Registration Statement and the Prospectus
and (A) as of the date of such certificate, such documents do not contain
an untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary in order to make the
statements therein (in the case of the Prospectus, in light of the
circumstances under which they were made) not misleading and (B) since
the Effective Date no event has occurred as a result of which it is
necessary to amend or supplement the Registration Statement or Prospectus
in order to make the statements therein, in light of the circumstances
under which they were made, not untrue or misleading in any material
respect, and (C) there has been no document required to be filed under
the Exchange Act and the Exchange Act Regulations that upon such filing
would be incorporated by reference into the Prospectus that has not been
so filed.
(f) All of the representations and warranties of the Selling
Stockholders contained in this Agreement shall be true and correct on the
Closing Date with the same force and effect as if made on and as of the
Closing Date and the Underwriters shall have received a certificate,
dated the Closing Date, signed by an authorized officer, partner, member,
manager, trustee or similar person of such Selling Stockholder, if not an
individual, or by such Selling Stockholder, if an individual, to the
effect that the person signing such certificate has examined the
Registration Statement, the Prospectus and this Agreement and the
representations and warranties of such Selling Stockholder in this
Agreement are true and correct in all material respects
<PAGE> 24
on and as of the Closing Date with the same force and effect as if made on
the Closing Date.
(g) At the Closing Date, the Underwriters and the Selling
Stockholders shall have received the opinion of Ellis, Funk, Goldberg,
Labovitz & Dokson, P.C., counsel for the Company, dated the Closing Date,
in form and substance reasonably satisfactory to the Underwriters and
Underwriters' counsel, to the effect set forth in Exhibit A hereto.
(h) At the Closing Date, the Underwriters and the Selling
Stockholders shall have received the opinion of Kelley Drye & Warren LLP,
special regulatory counsel for the Company, dated the date of its
delivery, addressed to the Underwriters and in form and substance
satisfactory to the Underwriters' counsel, to the effect set forth in
Exhibit B hereto.
(i) At the Closing Date, each Selling Stockholder shall have
delivered to the Underwriters the opinion of counsel for such Selling
Stockholder, in each case dated the Closing Date, in form and substance
reasonably satisfactory to the Underwriters and Underwriters' counsel, to
the effect set forth in Exhibit C hereto.
(j) At the time this Agreement is executed and at the Closing
Date the Underwriters and the Selling Stockholders shall have received
from Arthur Andersen LLP, independent certified public accountants for
the Company, dated as of the date of this Agreement and as of the Closing
Date, a customary comfort letter addressed to the Underwriters and in
form and substance satisfactory to the Underwriters and counsel to the
Underwriters with respect to the financial statements and certain
financial information of the Company together with each of its
subsidiaries contained in the Registration Statement and the Prospectus.
(k) Kronish Lieb Wiener & Hellman LLP shall have been furnished
with such documents, in addition to those set forth above, as they may
reasonably require for the purpose of enabling them to review or pass
upon the matters referred to in this Section 9 and in order to evidence
the accuracy, completeness or satisfaction in all material respects of
any of the representations, warranties or conditions herein contained.
(l) On or prior to the Closing Date, the Underwriters shall
have received the executed agreements referred to in Section 6(p) hereof.
(m) Prior to the Closing Date, the Company, its subsidiaries
and the Selling Stockholders shall have furnished to the Underwriters
such further information, certificates and documents as the Underwriters
may reasonably request.
(n) On or prior to the Closing Date, the Company shall have
filed a Notification Form for Listing Additional Shares on the Nasdaq
National Market, such Form for Listing Additional Shares shall have been
approved and a copy thereof shall have been provided by the Company to
the Underwriters.
<PAGE> 25
If any of the conditions specified in this Section 9 shall not have
been fulfilled when and as required by this Agreement, or if any of the
certificates, opinions, written statements or letters furnished to the
Underwriters or to Underwriters' counsel pursuant to this Section 9 shall not be
reasonably satisfactory in form and substance to the Underwriters and to
Underwriters' counsel, all of the obligations of the Underwriters hereunder may
be cancelled by the Underwriters at, or at any time prior to, the Closing Date.
Notice of such cancellation shall be given to the Company in writing, or by
telephone, telecopy, telex or telegraph, confirmed in writing.
10. Indemnification.
(a) The Company agrees to indemnify and hold harmless (i) each of
the Underwriters, (ii) each person, if any, who controls any of the
Underwriters within the meaning of Section 15 of the Act or Section 20(a)
of the Exchange Act and (iii) the respective officers, directors,
partners, employees, representatives and agents of any of the Underwriters
or any controlling person to the fullest extent lawful, from and against
any and all losses, liabilities, claims, damages and expenses whatsoever
(including but not limited to attorneys' fees and any and all expenses
whatsoever incurred in investigating, preparing or defending against any
investigation or litigation, commenced or threatened, or any claim
whatsoever, and any and all amounts paid in settlement of any claim or
litigation), joint or several, to which they or any of them may become
subject under the Act, the Exchange Act or otherwise, insofar as such
losses, liabilities, claims, damages or expenses (or actions in respect
thereof) arise out of or are based upon any untrue statement or alleged
untrue statement of a material fact contained in the Registration
Statement as originally filed or any amendment thereof, or any related
preliminary prospectus or the Prospectus, or in any supplement thereto or
amendment thereof, or arise out of or are based upon the omission or
alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein (in the case of the
preliminary prospectus or the Prospectus, in light of the circumstances
under which they were made) not misleading; provided, however, that the
Company will not be liable in any such case to the extent, but only to the
extent, that any such loss, liability, claim, damage or expense arises out
of or is based upon any such untrue statement or alleged untrue statement
or omission or alleged omission made therein in reliance upon and in
conformity with written information furnished to the Company by or on
behalf of the Underwriters expressly for use therein. This indemnity
agreement will be in addition to any liability which the Company may
otherwise have, including, under this Agreement.
(b) Each Selling Stockholder, severally but not jointly, agrees to
indemnify and hold harmless (i) each of the Underwriters, (ii) each
person, if any, who controls any of the Underwriters within the meaning of
Section 15 of the Act or Section 20(a) of the Exchange Act and (iii) the
respective officers, directors, partners, employees, representatives and
agents of any of the Underwriters or any controlling person to the fullest
extent lawful, from and against any and all losses, liabilities, claims,
damages and expenses whatsoever (including but not limited to attorneys'
fees and any and all expenses whatsoever incurred in investigating,
preparing or defending against any investigation or litigation, commenced
or threatened, or any claim whatsoever, and any
<PAGE> 26
and all amounts paid in settlement of any claim or litigation), joint or
several, (x) to which they or any of them may become subject, insofar as
such losses, liabilities, claims, damages or expenses (or actions in
respect thereof) arise out of or are based upon the breach of the
representations or warranties made by the Selling Stockholders in Section
7(2)(b) of this Agreement, or (y) to which they or any of them may become
subject under the Act, the Exchange Act or otherwise, insofar as such
losses, liabilities, claims, damages or expenses (or actions in respect
thereof) arise out of or are based upon any untrue statement or alleged
untrue statement of a material fact contained in the Registration
Statement as originally filed or any amendment thereof, or any related
preliminary prospectus or the Prospectus, or in any supplement thereto or
amendment thereof, or arise out of or are based upon the omission or
alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein (in the case of the
preliminary prospectus or the Prospectus, in light of the circumstances
under which they were made) not misleading, in each case to the extent,
but only to the extent that such loss, liability, claim, damage or expense
arises out of or is based upon any such untrue statement or alleged untrue
statement or omission or alleged omission made therein in reliance upon
information furnished to the Company or the Underwriters by or on behalf
of such Selling Stockholder expressly for use therein; provided, however,
that in no case shall any Selling Stockholder be liable or responsible for
any amount in excess of the aggregate gross proceeds received by such
Selling Stockholder from the sale of such Selling Stockholder's Shares
hereunder. This indemnity agreement will be in addition to any liability
which any Selling Stockholder may otherwise have, including under this
Agreement.
(c) Each Underwriter, severally and not jointly, agrees to indemnify
and hold harmless the Company, each Selling Stockholder and each person,
if any, who controls the Company or such Selling Stockholder within the
meaning of Section 15 of the Act or Section 20(a) of the Exchange Act,
against any losses, liabilities, claims, damages and expenses whatsoever
(including but not limited to attorneys' fees and any and all expenses
whatsoever incurred in investigating, preparing or defending against any
investigation or litigation, commenced or threatened, or any claim
whatsoever and any and all amounts paid in settlement of any claim or
litigation), joint or several, to which they or any of them may become
subject under the Act, the Exchange Act or otherwise, insofar as such
losses, liabilities, claims, damages or expenses (or actions in respect
thereof) arise out of or are based upon any untrue statement or alleged
untrue statement of a material fact contained in the Registration
Statement, as originally filed or any amendment thereof, or any related
preliminary prospectus or the Prospectus, or in any amendment thereof or
supplement thereto, or arise out of or are based upon the omission or
alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading, in each case to
the extent, but only to the extent, that any such loss, liability, claim,
damage or expense arises out of or is based upon any untrue statement or
alleged untrue statement or omission or alleged omission made therein in
reliance upon and in conformity with written information furnished to the
Company by or on behalf of any Underwriter expressly for use therein;
provided, however, that in no case shall any Underwriter be liable or
responsible for any amount
<PAGE> 27
in excess of the discounts and commissions received by such Underwriter,
as set forth on the cover page of the Prospectus. This indemnity agreement
will be in addition to any liability which any Underwriter may otherwise
have, including under this Agreement.
(d) Promptly after receipt by an indemnified party under
subsection (a), (b) or (c) above of notice of the commencement of any
action, such indemnified party shall, if a claim in respect thereof is to
be made against the indemnifying party under such subsection, notify each
party against whom indemnification is to be sought in writing of the
commencement thereof (but the failure so to notify an indemnifying party
shall not relieve it from any liability which it may have under this
Section 10 except to the extent that it has been prejudiced in any
material respect by such failure or from any liability which it may
otherwise have). In case any such action is brought against any
indemnified party, and it notifies an indemnifying party of the
commencement thereof, the indemnifying party will be entitled to
participate therein, and to the extent it may elect by written notice
delivered to the indemnified party promptly after receiving the aforesaid
notice from such indemnified party, to assume the defense thereof with
counsel reasonably satisfactory to such indemnified party.
Notwithstanding the foregoing, the indemnified party or parties shall
have the right to employ its or their own counsel in any such case (and
where the Underwriters are the indemnified parties, Bear Stearns shall
have the right to select such counsel for the Underwriters), but the fees
and expenses of such counsel shall be at the expense of such indemnified
party or parties unless (i) the employment of such counsel shall have
been authorized in writing by the indemnifying parties in connection with
the defense of such action, (ii) the indemnifying parties shall not have
employed counsel to take charge of the defense of such action within a
reasonable time after notice of commencement of the action, or (iii) such
indemnified party or parties shall have reasonably concluded that there
may be defenses available to it or them which are different from or
additional to those available to one or all of the indemnifying parties
(in which case the indemnifying party or parties shall not have the right
to direct the defense of such action on behalf of the indemnified party
or parties), in any of which events such fees and expenses of counsel
shall be borne by the indemnifying parties; provided, however, that the
indemnifying party under subsection (a), (b) or (c) above, shall only be
liable for the legal expenses of one counsel (in addition to any local
counsel) for all indemnified parties in each jurisdiction in which any
claim or action is brought. Anything in this subsection to the contrary
notwithstanding, an indemnifying party shall not be liable for any
settlement of any claim or action effected without its prior written
consent; provided, however, that such consent was not unreasonably
withheld.
11. Contribution. In order to provide for contribution in circumstances
in which the indemnification provided for in Section 10 is for any reason held
to be unavailable from the Company or any of the Selling Stockholders or is
insufficient to hold harmless a party indemnified thereunder, the Company, the
Selling Stockholders and the Underwriters shall contribute to the aggregate
losses, claims, damages, liabilities and expenses of the nature contemplated by
such indemnification provision (including any investigation, legal and other
expenses incurred in connection with, and any amount paid in settlement of, any
action, suit or proceeding or any claims
<PAGE> 28
asserted, but after deducting in the case of losses, claims, damages,
liabilities and expenses suffered by the Company or any Selling Stockholder,
any contribution received by the Company or any Selling Stockholder from
persons, other than the Underwriters, who may also be liable for contribution,
including persons who control the Company or such Selling Stockholder within
the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act) to
which the Company and any Selling Stockholder, on the one hand, and any of the
Underwriters, on the other hand, may be subject, in such proportion as is
appropriate to reflect the relative benefits received by the Company and the
Selling Stockholders, on the one hand, and the Underwriters, on the other hand,
from the sale of the Shares or, if such allocation is not permitted by
applicable law or indemnification is not available as a result of the
indemnifying party not having received notice as provided in Section 10, in
such proportion as is appropriate to reflect not only the relative benefits
referred to above but also the relative fault of the Company and the Selling
Stockholders, on the one hand, and the Underwriters, on the other hand, in
connection with the statements or omissions which resulted in such losses,
claims, damages, liabilities or expenses, as well as any other relevant
equitable considerations. The relative benefits received by the Company and the
Selling Stockholders, on the one hand, and the Underwriters, on the other hand,
shall be deemed to be in the same proportion as (x) the total proceeds from the
sale of Shares (net of discounts but before deducting expenses) received by the
Company or any Selling Stockholder and (y) the underwriting discounts and
commissions received by the Underwriters, respectively, in each case as set
forth in the table on the cover page of the Prospectus. The relative fault of
the Company, the Selling Stockholders and of the Underwriters shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to
state a material fact relates to information supplied by the Company, the
Selling Stockholders or the Underwriters and the parties' relative intent,
knowledge, access to information and opportunity to correct or prevent such
statement or omission. The Company, the Selling Stockholders and the
Underwriters agree that it would not be just and equitable if contribution
pursuant to this Section 11 were determined by pro rata allocation or by any
other method of allocation which does not take into account the equitable
considerations referred to above. Notwithstanding the provisions of this
Section 11, (i) in no case shall any Underwriter be required to contribute any
amount in excess of the amount by which the underwriting discount applicable to
the Shares purchased by such Underwriter pursuant to this Agreement exceeds the
amount of any damages which such Underwriter has otherwise been required to pay
by reason of any untrue or alleged untrue statement or omission or alleged
omission, (ii) the aggregate liability of any Selling Stockholder pursuant to
the provisions of this paragraph shall be limited to an amount equal to the
aggregate gross proceeds received by such Selling Stockholder from the sale of
such Selling Stockholder's Shares hereunder and (iii) no person guilty of
fraudulent misrepresentation (within the meaning of Section 11(f) of the Act)
shall be entitled to contribution from any person who was not guilty of such
fraudulent misrepresentation. For purposes of this Section 11, (A) each person,
if any, who controls any Underwriter within the meaning of Section 15 of the
Act or Section 20(a) of the Exchange Act and (B) the respective officers,
directors, partners, employees, representatives and agents of any of the
Underwriters or any controlling person shall have the same rights to
contribution as such Underwriters; and each person, if any, who controls the
Company within the meaning of Section 15 of the Act or Section 20(a) of the
Exchange Act shall have the same rights to contribution as the Company; and
each person who controls each Selling Stockholder within the meaning of Section
15 of the Act or Section 20(a) of the Exchange Act shall have the same rights
to contribution as such Selling Stockholder, subject in each case to clauses
(i), (ii) and (iii) of this
<PAGE> 29
Section 11. Any party entitled to contribution will, promptly after receipt of
notice of commencement of any action, suit or proceeding against such party in
respect of which a claim for contribution may be made against another party or
parties under this Section 11, notify such party or parties from whom
contribution may be sought, but the failure to so notify such party or parties
shall not relieve the party or parties from whom contribution may be sought
from any obligation it or they may have under this Section 11 or otherwise. No
party shall be liable for contribution with respect to any action or claim
settled without its prior written consent; provided, however, that such written
consent was not unreasonably withheld.
12. Substitution of Underwriters.
(a) If any Underwriter or Underwriters shall default in its or
their obligation to purchase Shares hereunder, and if the total number of
Shares with respect to which such default relates do not (after giving
effect to arrangements, if any, made pursuant to subsection (b) below)
exceed 10% of the total number of Shares which the Underwriters have
agreed to purchase hereunder, then such Shares to which the default
relates shall be purchased by the non-defaulting Underwriters in
proportion to the respective proportions which the number of Shares set
forth opposite their respective names on Schedule II hereto bear to the
total number of Shares set forth opposite the names of the non-defaulting
Underwriters.
(b) In the event that such default relates to more than 10% of
the total number of Shares, the non-defaulting Underwriters may in their
discretion arrange for themselves or for another party or parties to
purchase the Shares to which such default relates on the terms contained
herein. In the event that within five (5) calendar days after such a
default the non-defaulting Underwriters do not arrange for the purchase
of the Shares to which such default relates as provided in this Section
12, this Agreement and the obligations of the Underwriters to purchase,
and of the Company to sell, the Shares shall thereupon terminate without
liability on the part of the Company with respect thereto (except in each
case as provided in Sections 8, 10(a), 10(b) and 11) or the Selling
Stockholders (except as provided in Sections 10(a), 10(b), 11 and 14(a))
or the Underwriters (except as provided in Sections 10(c) and 11), but
nothing in this Agreement shall relieve a defaulting Underwriter of its
liability, if any, to the other Underwriters and the Company for damages
occasioned by its default hereunder.
(c) In the event that the Shares to which the default relates
are to be purchased by the non-defaulting Underwriters, or are to be
purchased by another party or parties as aforesaid, the Underwriters or
the Company shall have the right to postpone the Closing Date for a
period not exceeding five (5) business days in order to effect whatever
changes may thereby be made necessary in the Registration Statement or
the Prospectus or in any other documents and arrangements, and the
Company agrees to file promptly any amendment or supplement to the
Registration Statement or the Prospectus which, in the opinion of
Underwriters' counsel, may thereby be made necessary or advisable. The
term "Underwriter" as used in this Agreement shall include any party
substituted under this
<PAGE> 30
Section 12 with like effect as if it had originally been a party to this
Agreement with respect to such Shares.
13. Effective Date of Agreement; Termination.
(a) This Agreement shall become effective when the Underwriters
and the Company shall have received notification of the effectiveness of
the Registration Statement. Until this Agreement becomes effective as
aforesaid, it may be terminated by the Company by notifying the
Underwriters or by the Underwriters by notifying the Company.
Notwithstanding the foregoing, the provisions of this Section 13 and of
Sections 8, 10, 11 and 14(a) shall at all times be in full force and
effect.
(b) The Underwriters shall have the right to terminate this
Agreement at any time prior to the Closing Date by notice to the Company
from the Underwriters, without liability (other than with respect to
Sections 10 and 11) on the Underwriters' part to the Sellers if, on or
prior to such date, (i) the Company or any Selling Stockholder shall have
failed, refused or been unable to perform in any material respect any
agreement on its part to be performed hereunder, (ii) any other condition
to the obligations of the Underwriters hereunder as provided in Section 9
is not fulfilled when and as required in any material respect, (iii) in
the reasonable judgment of the Underwriters any material adverse change
shall have occurred since the respective dates as of which information is
given in the Registration Statement in the condition (financial or
otherwise), business, properties, assets, liabilities, prospects, net
worth, results of operations or cash flows of the Company and the
subsidiaries taken as a whole, or (iv)(A) any domestic or international
event or act or occurrence has materially disrupted, or in the opinion of
the Underwriters will in the immediate future materially disrupt, the
market for the Company's securities or for securities in general; or (B)
trading in securities generally on the New York or American Stock
Exchanges shall have been suspended or materially limited, or minimum or
maximum prices for trading shall have been established, or maximum ranges
for prices for securities shall have been required, on such exchange, or
by such exchange or other regulatory body or governmental authority
having jurisdiction; or (C) a banking moratorium shall have been declared
by Federal or state authorities, or a moratorium in foreign exchange
trading by major international banks or persons shall have been declared;
or (D) there is an outbreak or escalation of armed hostilities involving
the United States on or after the date hereof, or if there has been a
declaration by the United States of a national emergency or war, the
effect of which shall be, in the Underwriters' judgment, to make it
inadvisable or impracticable to proceed with the offering or delivery of
the Shares on the terms and in the manner contemplated in the
Registration Statement; or (E) there shall have been such a material
adverse change in general economic, political or financial conditions or
if the effect of international conditions on the financial markets in the
United States shall be such as, in the Underwriters' judgment, makes it
inadvisable or impracticable to proceed with the delivery of the Shares
as contemplated hereby.
(c) Any notice of termination pursuant to this Section 13 shall
be by telephone, telex, telephonic facsimile, or telegraph, confirmed in
writing by letter.
<PAGE> 31
(d) If this Agreement shall be terminated pursuant to any of
the provisions hereof (otherwise than pursuant to (i) notification by the
Underwriters as provided in Section 13(a) or (ii) Section 12(b)), or if
the sale of the Shares provided for herein is not consummated because any
condition to the obligations of the Underwriters set forth herein is not
satisfied or because of any refusal, inability or failure on the part of
the Company or the Selling Stockholders to perform any agreement herein
or comply with any provision hereof, the Company will, subject to demand
by the Underwriters, reimburse the Underwriters for all out-of-pocket
expenses (including, without limitation, the reasonable fees and expenses
of Underwriters' counsel) incurred by the Underwriters in connection
herewith.
14. Agreements of the Selling Stockholders. Each Selling Stockholder
severally agrees with the Underwriters and the Company:
(a) To pay or to cause to be paid all transfer taxes with
respect to the Shares to be sold by such Selling Stockholder and all
other expenses required to be paid by such Selling Stockholder pursuant
to the terms of the Warrant Registration Rights Agreement, the Series A
Agreement, the Series B Agreement or the Merger Agreement; and
(b) To take all reasonable actions in cooperation with the
Company and the Underwriters to cause the Registration Statement to
become effective at the earliest possible time, to do and perform all
things to be done and performed under this Agreement prior to the Closing
Date and to satisfy all conditions precedent to the delivery of the
Shares pursuant to this Agreement.
15. Survival of Representations and Agreements. All representations
and warranties, covenants and agreements of the Underwriters, the Company and
the Selling Stockholders contained in this Agreement, including, without
limitation, the agreements contained in Sections 8, 13(d) and 14(a), the
indemnity agreements contained in Section 10 and the contribution agreements
contained in Section 11, shall remain operative and in full force and effect
regardless of any investigation made by or on behalf of any Underwriter, any
controlling person thereof or by or on behalf of the Company or any controlling
person thereof, and shall survive delivery of and payment for the Shares to and
by the Underwriters. The representations contained in Section 7 and the
agreements contained in Sections 8, 10, 11, 13(d) and 14(a) shall survive the
termination of this Agreement, including, without limitation, any termination
pursuant to Sections 12 or 13.
16. Notice. All communications hereunder, except as may be otherwise
specifically provided herein, shall be in writing and, if sent to the
Underwriters shall be mailed, delivered, or telexed, telegraphed or telecopied
and confirmed in writing c/o Bear, Stearns & Co. Inc., Goldman, Sachs & Co. and
ING Barings LLC, c/o Bear, Stearns & Co. Inc., 245 Park Avenue, New York, New
York 10167, Attention: Corporate Finance Department, telecopy number: (212)
272-3092; and if sent to the Company, shall be mailed, delivered or telexed,
telegraphed or telecopied and confirmed in writing to MGC Communications, Inc.,
3301 N. Buffalo Drive, Las Vegas, Nevada 89129, Attention: Chief Financial
Officer, telecopy number: (702) 310-5715, with a copy to Ellis, Funk, Goldberg,
Labovitz & Dokson, P.C., One Securities Centre, Suite 400, 3490 Piedmont Road,
Atlanta, Georgia 30305, telecopy number: (404)
<PAGE> 32
233-2188; and if sent to the Selling Stockholders, shall be mailed, delivered
or telexed, telegraphed or telecopied and confirmed in writing to David S.
Clark or Linda M. Sunbury c/o MGC Communications, Inc., 3301 N. Buffalo Drive,
Las Vegas, Nevada 89129; provided, however, that any notice to any party
pursuant to Section 10 or 11 shall be mailed, delivered or telexed, telegraphed
or telecopied and confirmed in writing to such party.
17. Parties. This Agreement shall inure solely to the benefit of, and
shall be binding upon, the Underwriters and the Sellers and the controlling
persons and agents referred to in Sections 10 and 11, and their respective
successors and assigns, and no other person shall have or be construed to have
any legal or equitable right, remedy or claim under or in respect of or by
virtue of this Agreement or any provision herein contained. The term
"successors and assigns" shall not include a purchaser, in its capacity as
such, of Shares from the Underwriters.
18. Construction. This Agreement shall be construed in accordance with
the internal laws of the State of New York.
19. Captions. The captions included in this Agreement are included
solely for convenience of reference and are not to be considered a part of this
Agreement.
20. Counterparts. This Agreement may be executed by the parties hereto
in separate counterparts, each of which when so executed and delivered shall be
an original, but all of which shall together constitute one and the same
instrument.
[Signature page to follow]
<PAGE> 33
If the foregoing correctly sets forth the understanding among
the Underwriters and the Company, please so indicate in the space provided
below for that purpose, whereupon this letter shall constitute a binding
agreement between us.
<TABLE>
<S> <C>
Very truly yours,
MGC COMMUNICATIONS, INC.
By:
---------------------
Name:
Title:
THE SELLING STOCKHOLDERS NAMED
ON SCHEDULE I HERETO
By:
----------------------------------
Name:
Title:
Accepted and agreed to as of
the date first above written:
BEAR, STEARNS & CO. INC.
GOLDMAN, SACHS & CO.
ING BARINGS LLC
By: BEAR, STEARNS & CO. INC.
By:
-------------------------------
Name:
Title:
GOLDMAN, SACHS & CO.
By:
-------------------------------
Name:
Title:
</TABLE>
<PAGE> 34
ING BARINGS LLC
By:
---------------------------------
Name:
Title:
<PAGE> 35
Schedule I
SELLING STOCKHOLDERS
<TABLE>
<CAPTION>
Selling Stockholder Shares
- ------------------- ------
<S> <C>
Winston Partners II LDC 33,436
Winston Partners II LLC 10,627
S-C Phoenix Holdings, LLC 171,428
Prospect Street High Income Portfolio Inc. 15,870
Strategic Investment Partners Ltd. 342,857
Libertyview Funds LP 2,695
CPR (USA) Inc. 8,357
Libertyview Enhanced High Yield Fund 2,425
</TABLE>
<PAGE> 36
Schedule II
Number of Shares
Underwriter to be Purchased
----------- ---------------
Bear, Stearns & Co. Inc.
Goldman, Sachs & Co.
ING Barings LLC
<PAGE> 37
Schedule III
Stockholders Subject to Lockup Agreements
Darren Adair
Marilyn Ash
John Boersma
Michael Burke
Patrick Chicas
Dave Clark
Charles Clay
Larry Costa
Raoul Fernandes
Timothy Flynn
Maurice Gallagher
Jack Hancock
Jeff Hein
Aida Herrera
Kent Heyman
Cornell Hudson
James Hurley
JK&B Capita, L.P.
JK&B Capital II, L.P.
JK&B Capital III, L.P.
Thomas Keough
David Kronfeld
Andrew Levy
Carol Mittwede
Nield Montgomery
Janet Nogle
Thomas Neustaetter
Lucinda O'Mara
Molly Pace
Mark Peterson
David Rahm
Walter Rusak
Linda Sunbury
<PAGE> 38
EXHIBIT A
Form of Opinion of Ellis, Funk, Goldberg, Labovitz & Dokson, P.C.
1. Each of the Company and its subsidiaries (A) is duly organized and
validly existing as a corporation in good standing under the laws of its
jurisdiction of incorporation, (B) has all requisite corporate power and
authority to carry on its business as it is being conducted and as described in
the Registration Statement and Prospectus and to own, lease and operate its
properties, and (C) is duly qualified and in good standing as a foreign
corporation authorized to do business in each jurisdiction in which the nature
of its business or its ownership or leasing of property requires such
qualification except, with respect to this clause (C), where the failure to be
so qualified or in good standing does not and could not reasonably be expected
to have a Material Adverse Effect. All of the issued and outstanding shares of
capital stock of, or other ownership interests in, each subsidiary have been
duly authorized and validly issued, are fully paid and non-assessable and were
not issued in violation of or subject to any preemptive or similar rights under
the Nevada General Corporation Law, or known to us, after reasonable inquiry,
and are owned by the Company of record, and to our knowledge, after reasonable
inquiry, beneficially, free and clear of any security interest, mortgage,
pledge, lien, encumbrance, claim or other restriction on transferability or
voting. Except for the capital stock of the subsidiaries owned by the Company,
to our knowledge, neither the Company nor any of its subsidiaries owns or holds
any interest in any corporation, partnership, trust or association, joint
venture or other entity.
2. All the outstanding shares of capital stock of the Company
(including the Shares to be sold by the Selling Stockholders) and each
subsidiary have been duly authorized, validly issued, and are fully paid and
nonassessable and were not issued in violation of any preemptive or similar
rights. The authorized, issued and outstanding capital stock of the Company
conforms in all respects to the description thereof set forth in the
Registration Statement and Prospectus. Except as set forth in the Prospectus,
there are no outstanding subscriptions, rights, warrants, calls, commitments of
sale or options to acquire (other than options issued during the period
commencing on the date of the Underwriting Agreement and ending on the Closing
Date pursuant to the Stock Option Plan in accordance with the third paragraph
of Section 3 of the Underwriting Agreement), or instruments convertible into or
exercisable or exchangeable for, any capital stock or other equity interest in
the Company or any of its subsidiaries known to us, after reasonable inquiry.
None of the outstanding shares of the capital stock of the Company or the
subsidiaries were issued in violation of the registration requirements of the
Act or the registration or qualification requirements of the applicable state
securities or "Blue Sky" laws.
3. The Company has all requisite corporate power and authority to
execute, deliver and perform its obligations under the Underwriting Agreement
to consummate the transactions contemplated thereby, including, without
limitation, the corporate power and authority to issue, sell and deliver the
Company Shares as provided therein.
4. The Underwriting Agreement has been duly and validly authorized,
executed and
<PAGE> 39
delivered by the Company and, assuming due execution by the other parties
thereto, is the legally valid and binding agreement of the Company.
5. The Company Shares have been duly authorized and, when issued and
delivered to the Underwriters against payment therefor in accordance with the
terms of the Underwriting Agreement, will be validly issued, fully paid and
nonassessable and, to our knowledge after reasonable inquiry, free of any
preemptive or similar rights that entitle or will entitle any person to acquire
any Shares upon the issuance thereof by the Company.
6. The statements under the caption "Description of Securities" in the
Prospectus, insofar as such statements constitute a summary of documents
referred to therein, present a fair summary thereof.
7. None of (A) the execution, delivery or performance by the Company of
the Underwriting Agreement or (B) the issuance of the Company Shares and the
sale of the Shares by the Company and the Selling Stockholders violates,
conflicts with or constitutes a breach of any of the terms or provisions of, or
a default under (or an event that with notice or the lapse of time, or both,
would constitute a default), or require consent under, or result in the
imposition of a lien or encumbrance on any properties of the Company or any
subsidiary, or an acceleration of any indebtedness of the Company or any
subsidiary pursuant to, (i) the charter or bylaws of the Company or any
subsidiary, (ii) any bond, debenture, note, indenture, mortgage, deed of trust
or other agreement or instrument known to us to which the Company or any
subsidiary is a party or by which any of them or their property is or may be
bound, (iii) any local, state, federal or administrative statute, rule or
regulation applicable to the Company or any subsidiary or any of their
respective assets or properties (except that we express no opinion as to the
matters addressed by the opinion of Kelley Drye & Warren LLP) or (iv) any
judgment, order or decree of any court or governmental agency or authority
having jurisdiction over the Company or any subsidiary or any of their assets
or properties known to us (except that we need express no opinion as to the
matters addressed by the opinion of Kelley Drye & Warren LLP), except that the
Company has not received written approval from the Georgia Public Service
Commission as to the sale of the Company Shares and except in the case of
clauses (ii), (iii) and (iv) for such violations, conflicts, breaches,
defaults, consents, impositions of liens or accelerations that (x) would not,
singly or in the aggregate, have a Material Adverse Effect or (y) are disclosed
in the Registration Statement. Assuming compliance with applicable state
securities and Blue Sky laws, as to which we express no opinion, and except for
the filing of a registration statement under the Act and for the approval
required to be obtained by the Georgia Public Service Commission, no consent,
approval, authorization or order of, or filing, registration, qualification,
license or permit of or with, any court or governmental agency, body or
administrative agency is required for (1) the execution, delivery and
performance by the Company of the Underwriting Agreement, or (2) the issuance
of the Company Shares and the sale of the Shares by the Company and the Selling
Stockholders, except such as have been obtained and made or have been disclosed
in the Registration Statement, and except where the failure to obtain such
consents or waivers would not, singly or in the aggregate, have a Material
Adverse Effect. To our knowledge, after reasonable inquiry, no consents or
waivers from any other person are required for the execution, delivery and
performance by the Company of the Underwriting Agreement or the issuance of the
Company Shares and the sale of the Shares by the Company and the Selling
Stockholders, other than such
<PAGE> 40
consents and waivers as have been obtained and except that we express no
opinion as to the matters addressed in the opinion of Kelley Drye & Warren LLP.
8. None of the Company or the subsidiaries is (i) an "investment
company" or a company "controlled" by an "investment company" within the
meaning of the Investment Company Act of 1940, as amended or (ii) a "holding
company" or a "subsidiary company" or an "affiliate" of a holding company
within the meaning of the Public Utility Holding Company Act of 1935, as
amended.
9. Except for the Shares sold by the Selling Stockholders, no holders
of any securities of the Company or of any subsidiary or their respective
affiliates or of any options, warrants or other convertible or exchangeable
securities of the Company or any subsidiary or their respective affiliates are
entitled to include any such securities in or to have such securities
registered under the Registration Statement.
10. Except as set forth in the Prospectus, to our knowledge, after
reasonable inquiry, there is (i) no action, suit, investigation or proceeding
(other than proceedings with respect to pending license applications) before or
by any court, arbitrator or governmental agency, body or official, domestic or
foreign, now pending, or threatened or contemplated to which any of the Company
or any subsidiary is or may be a party or to which the business or property of
the Company or any of its subsidiaries is or may be subject, (ii) no statute,
rule, regulation or order that has been enacted, adopted or issued by any
governmental agency or that has been proposed by any governmental body (except
that we need express no opinion with respect to Telecommunications Laws) or
(iii) no injunction, restraining order or order of any nature by a federal or
state court of competent jurisdiction to which any of the Company or any
subsidiary is or may be subject or to which the business, assets or property of
the Company or any of its subsidiaries are or may be subject has been issued
that, in the case of clauses (i), (ii) and (iii) above, (x) is required to be
disclosed in the Registration Statement or the Prospectus, (y) could reasonably
be expected to have, either individually or in the aggregate, a Material
Adverse Effect or (z) might interfere with, adversely affect or in any manner
question the validity of the issuance of the Company Shares and the sale of the
Shares by the Company and the Selling Stockholders or any of the other
transactions contemplated by the Underwriting Agreement and the Registration
Statement and except that we express no opinion as to the matters addressed in
the opinion of Kelley Drye & Warren LLP.
11. We are not aware of any order directed to any document incorporated
by reference in the Registration Statement which has been issued by the
Commission or any challenge that has been made by the Commission as to the
accuracy or adequacy of any such document.
12. The Company and the transactions contemplated by the Underwriting
Agreement meet the requirements for using Form S-3 under the Act. The
Registration Statement and the Prospectus, and the documents filed under the
Act and the Exchange Act and incorporated by reference in the Registration
Statement and the Prospectus or any amendment thereof or supplement thereto or
from which information is so incorporated by reference (other than financial
statements, notes and schedules thereto and other financial and accounting
information included or incorporated by reference therein, as to which we
express no opinion) comply as to form in all material respects with the Act or
the Exchange Act, as the case may be, and the Regulations.
<PAGE> 41
13. The Registration Statement was declared effective under the Act on
July 21, 1999. To our knowledge, after reasonable inquiry, no stop order
suspending the effectiveness of the Registration Statement or preventing or
suspending the use of any preliminary prospectus has been issued, and no
proceedings for that purpose have been instituted or threatened.
14. There are no contracts or documents of the Company or any of its
subsidiaries known to us, after reasonable inquiry, that are required to be
filed (A) as exhibits to the Registration Statement by the Act, or (B) as
exhibits to any of the documents incorporated by reference by the Exchange Act
or (C) by the Regulations that have not been so filed. Insofar as statements in
the Prospectus (other than statements addressed in the opinion of Kelley Drye &
Warren LLP) purport to summarize the provisions of laws, rules, regulations,
proposed rules, proposed regulations, orders, judgments, decrees, contracts,
agreements, instruments, leases or licenses, such statements accurately reflect
the status of such provisions purported to be summarized and are correct in all
material respects.
15. The Company has authorized capital stock as set forth in the
Prospectus. All the shares of capital stock of the Company outstanding prior to
the issuance of the Company Shares are duly and validly authorized and issued,
are fully paid and nonassessable and were not issued in violation of or subject
to any preemptive rights.
16. The form of certificates for the Shares conforms to the equirements
of the General Corporation Law of the State of Nevada.
17. The Company's Notification Form for Listing Additional Shares on
the Nasdaq National Market has been filed and approved.
We have participated in conferences with officers and other
representatives of the Company, representatives of the independent certified
public accountants of the Company and the Underwriters and their
representatives at which the contents of the Prospectus and the Registration
Statement and any amendment thereof or supplement thereto and related matters
were discussed and, although we have not undertaken to investigate or verify
independently, and do not assume any responsibility for, the accuracy,
completeness or fairness of the statements contained in the Prospectus and the
Registration Statement or any amendment thereof or supplement thereto (except
as indicated above), on the basis of the foregoing, no facts have come to our
attention which led us to believe that the Prospectus and the Registration
Statement (or any amendment thereof made prior to the Closing Date as of the
date of such amendment) as of its date or the Closing Date, contained an untrue
statement of a material fact or omitted to state any fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading (except as to
financial statements and related notes, the financial statement schedules and
other financial data included therein).
We are members of the Bar of the State of Georgia, and we do not
herein express an opinion as to any matters governed by any laws other than the
laws of the State of Georgia, the laws of the State of Nevada governing
corporations and the Federal laws of the United States of America. In rendering
this opinion, we have relied on Kronish, Lieb, Weiner & Hellman LLP as
<PAGE> 42
to the laws of the State of New York.
<PAGE> 43
EXHIBIT B
Form of Opinion of Kelley Drye & Warren LLP
1. All of the licenses, permits and authorizations required by
the FCC for the provision of telecommunications services by the Company and the
subsidiaries, as we understand those services to be provided currently based
upon the Prospectus and the Registration Statement, have been issued to and are
validly held by the Company and the subsidiaries. All of the licenses, permits
and authorizations required by any "state commissions" as defined in Section 3
of the Communications Act of 1934, as amended (the "State Telecommunications
Agencies") for the provision of telecommunications services by the Company and
the subsidiaries, as we understand those services to be provided currently
based upon the Registration Statement, have been issued to and, to the best of
our knowledge, are validly held by the Company and the subsidiaries, except
where the failure to obtain or hold such license, permit or authority would not
have a Material Adverse Effect. All such licenses, permits and authorizations
are in full force and effect.
2. Neither the Company nor its subsidiaries is the subject of any
proceeding (including a rule making proceeding), pending complaint or
investigation, or, to the best of our knowledge, any threatened complaint or
investigation, before the FCC, or, to the best of our knowledge after oral
inquiry, of any proceeding (including a rule making proceeding), pending
complaint or investigation, or any threatened complaint or investigation,
before the State Telecommunications Agencies based, in each case, on any
alleged violation of any statutes governing the FCC or the State
Telecommunications Agencies and the rules and regulations promulgated
thereunder (the "Telecommunications Laws") by the Company or any subsidiary in
connection with their provision of or failure to provide telecommunications
services of a character required to be disclosed in the Registration Statement
which is not disclosed in the Registration Statement.
3. The statements in the Registration Statement under the
headings of "Risk Factors - Our services are highly regulated and changes in
current or future laws or regulations could restrict the way we operate our
business" and "Business - Regulation" regarding the Telecommunications Laws of
the FCC or the State Telecommunications Agencies fairly and accurately
summarize the matters therein described.
4. The Company and its subsidiaries have the consents, approvals,
authorizations, licenses, certificates, permits, or orders of the FCC or the
State Telecommunications Agencies, if any is required, for the consummation of
the transactions contemplated in the Registration Statement, except where the
failure to obtain the consents, approvals, authorizations, licenses,
certificates, permits or orders would not have a Material Adverse Effect.
5. Neither the execution and delivery of the Underwriting
Agreement nor the sale of the Shares contemplated thereby will conflict with or
result in a violation of any Telecommunications Laws applicable to the Company
or its subsidiaries, except where the conflict with or the violation of any
Telecommunications Laws would not have a Material Adverse Effect.
<PAGE> 44
6. In connection with our representation of the Company and its
subsidiaries, except as disclosed in the Registration Statement or the
Prospectus, we have not become aware of any Telecommunications Laws that could
reasonably be expected to have a Material Adverse Effect on the business of the
Company, taken as a whole, as described in the Prospectus and the Registration
Statement. The foregoing assumes that the Company currently is in substantial
compliance with all material Telecommunications Laws applicable to it except as
disclosed in the Registration Statement or the Prospectus.
<PAGE> 45
EXHIBIT C
[FORM OF OPINION OF COUNSEL TO SELLING STOCKHOLDERS]
[Letterhead of Counsel]
July __, 1999
Bear, Stearns & Co. Inc.
Goldman, Sachs & Co.
ING Barings LLC
c/o Bear, Stearns & Co. Inc.
245 Park Avenue
New York, New York 10167
Re: MGC Communications, Inc.
Ladies and Gentlemen:
We have acted as counsel for each of the selling stockholders listed of
Schedule A hereto (the "Selling Stockholders"), in connection with the
sale by the Selling Stockholders of ______________ shares of common stock
(the "Securities") of MGC Communications, Inc. (the "Company") to Bear,
Stearns & Co. Inc., Goldman, Sachs & Co. and ING Barings LLC (together,
the "Underwriters"). The sale is being made pursuant to an underwriting
agreement (the "Underwriting Agreement") dated as of July __, 1999, by and
among the Company, the Selling Stockholders and the Underwriters.
This opinion is delivered to the Underwriters at the request of the
Selling Stockholders pursuant to Section 9(i) of the Underwriting
Agreement. All capitalized terms used herein and not otherwise defined
shall have the respective meanings assigned to them in the Underwriting
Agreement.
Based upon and subject to the limitations and qualifications set forth
herein, we are of the opinion that:
1. The Underwriting Agreement and the Custody Agreement relating
to the sale of the Securities by the Selling Stockholders, and the Power
of Attorney, dated as of __________, 1999, appointing David S. Clark and
Linda M. Sunbury as the attorneys in fact of the Selling Stockholders
have been duly authorized, executed and delivered by each Selling
Stockholder and are valid and binding on each Selling Stockholder, and
each Selling Stockholder has full legal right and authority to sell,
transfer and deliver in the manner provided in the Underwriting Agreement
and the Custody Agreement the Securities being sold by such Selling
Stockholder thereunder.
<PAGE> 46
2. The delivery by each Selling Stockholder to the several
Underwriters of certificates for the Securities being sold pursuant to
the Underwriting Agreement by such Selling Stockholder against payment
therefor as provided in the Underwriting Agreement will pass good and
marketable title to such Securities to the several Underwriters, free and
clear of all liens, encumbrances, equities and claims whatsoever.
3. No consent, approval, authorization or order of any court or
governmental agency or body known by us to be applicable to the
transactions contemplated in the Underwriting Agreement is required for
the consummation by each Selling Stockholder of the transactions
contemplated in the Underwriting Agreement, except such as may have been
obtained under the Securities Act of 1933, as amended, and such as may be
required under the blue sky laws of any jurisdiction in connection with
the purchase and distribution of the Securities by the Underwriters and
such other approvals as have been obtained and are listed on Schedule B
hereto.
4. Neither the sale of the Securities being sold by the Selling
Stockholders nor the consummation of any other of the transactions
contemplated in the Underwriting by any Selling Stockholder or the
fulfillment of the terms of the Underwriting Agreement by any Selling
Stockholder will conflict with, result in a breach or violation of, or
constitute a default under any law or the charter or by-laws of the
Selling Stockholder, if not an individual, or the terms of any indenture
or other agreement or instrument known to us and to which any Selling
Stockholder or, if not an individual, any of its subsidiaries, is a party
or bound, or any judgment, order or decree known to us to be applicable
to any Selling Stockholder or, if not an individual, any of its
subsidiaries, of any court, regulatory body, administrative agency,
governmental body or arbitrator having jurisdiction over any Selling
Stockholder or, if not an individual, any of its subsidiaries.
In rendering such opinions, we have relied (A) as to matters involving the
application of laws of any jurisdiction other than the State of [New York]
or the Federal laws of the United States, to the extent we deemed proper
[specify], upon the opinion of other counsel of good standing whom we
believe to be reliable and who are satisfactory to counsel for the
Underwriters (which opinions are attached hereto), and (B) as to matters
of fact, to the extent we deemed proper, on certificates of authorized
officers of the Selling Stockholders and public officials.
<PAGE> 47
EXHIBIT D
FORM OF LOCK-UP AGREEMENT
June __, 1999
Bear, Stearns & Co. Inc.
Goldman, Sachs & Co.
ING Barings LLC
c/o Bear, Stearns & Co. Inc.
245 Park Avenue
New York, NY 10167
MGC Communications, Inc.
3301 North Buffalo Drive
Las Vegas, Nevada 89103
Ladies and Gentlemen:
In order to induce Bear, Stearns & Co. Inc. ("Bear Stearns"),
Goldman, Sachs & Co. ("Goldman") and ING Barings LLC (together with Bear
Stearns and Goldman, the "Underwriters") and MGC Communications, Inc., a
Nevada corporation (the "Company"), to enter into an underwriting
agreement (the "Underwriting Agreement") pursuant to which the
Underwriters will purchase, severally but not jointly, shares of common
stock, par value $.001 per share, of the Company ("Common Stock"), the
undersigned hereby agrees that for a period of 90 days following the date
on which the Company's registration statement on Form S-3 (Commission file
No. 333-79863) shall become effective by order of the United States
Securities and Exchange Commission (the "Effective Date"), the undersigned
will not directly or indirectly offer to sell, sell, contract to sell,
grant an option for the sale of, assign, transfer, pledge, hypothecate or
otherwise encumber or dispose of (either pursuant to Rule 144 of the
regulations under the Securities Act of 1933, as amended, or otherwise)
any shares of Common Stock or any other securities issued by the Company
("Securities") registered in the undersigned's name or beneficially owned
by the undersigned, including without limitation, any Securities with
respect to which the undersigned becomes the registered or beneficial
owner after the date hereof, or dispose of any beneficial interest therein
without the prior written consent of Bear Stearns and the Company.
In order to enable you to enforce the aforesaid agreement and grant
of rights, the undersigned hereby consents to the placing of legends and
stop-transfer orders with the transfer agent of the Company's Securities
with respect to any of the Securities registered in the undersigned's
name or beneficially owned by the undersigned.
<PAGE> 48
This agreement shall be governed by and construed in accordance
with the laws of the State of New York, without giving effect to conflict
of law principles. Any legal action or proceeding with respect to this
agreement shall be brought exclusively in the courts of the State of New
York residing in the Borough of Manhattan or of the United States of
America for the Southern District of New York, and, by execution and
delivery of this agreement, the parties hereto hereby accept for
themselves and in respect of their property, generally and
unconditionally, the exclusive jurisdiction of the aforesaid courts.
This agreement shall be binding on the undersigned and his, her or
its respective heirs, personal representatives, successors and assigns.
------------------------------
Signature
------------------------------
Print Name of Stockholder
------------------------------
Print Name and Title of Officer
------------------------------
Print Address
------------------------------
Print Social Security
Number or Taxpayer I.D.Number
<PAGE> 1
EXHIBIT 5.1
[ELLIS, FUNK, GOLDBERG, LABOVITZ & DOKSON, P.C. LETTERHEAD]
July 20, 1999
MGC Communications, Inc.
3301 North Buffalo Drive
Las Vegas, Nevada, 89129
Re: MGC Communications, Inc. Registration Statement on Form S-3
Ladies and Gentlemen:
At your request, we have examined the Registration Statement on Form S-3
filed by MGC Communications, Inc. (the "Company"), a Nevada corporation, with
the Securities and Exchange Commission with respect to the registration under
the Securities Act of 1933, as amended, of 5,587,695 shares of Common Stock,
$.001 par value per share, of the Company ("the Common Stock"), including
5,000,000 shares to be sold by the Company and 587,695 shares to be sold by
certain selling stockholders named in the Registration Statement (the "Selling
Stockholders") to the underwriters named in the Registration Statement (the
"Underwriters"), for resale by them to the public, and 838,154 shares of Common
Stock subject to an over-allotment option granted to the Underwriters by the
Company.
As your counsel, and in connection with the preparation of the
Registration Statement, we have examined the originals or copies of such
documents, corporate records, certificates of public officials, officers of
the Company and other instruments relating to the authorization and issuance of
the Common Stock as we deemed relevant or necessary for the opinions herein
expressed. Upon the basis of the foregoing, it is our opinion that:
1. The shares of Common Stock to be sold by the Selling Stockholders as
described in the Registration Statement are legally issued, fully-paid
and nonassessable.
2. The shares of Common Stock to be issued and sold by the Company to the
Underwriters will be, upon issuance, sale and delivery in the manner
and under the terms and conditions described in the Registration
Statement, legally issued, fully-paid and nonassessable.
We hereby consent to the use of this opinion as an exhibit to the
Registration Statement and further consent to the use of our name in the "Legal
Matters" section of the Registration Statement, including the Prospectus
constituting a part thereof, and any amendments thereto.
Your truly,
ELLIS, FUNK, GOLDBERG, LABOVITZ & DOKSON, P.C.
By: /s/ Robert B. Goldberg
------------------------------------------
Robert B. Goldberg
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
included in this Registration Statement and to the incorporation by reference in
this Registration Statement of our report dated March 2, 1999 included in MGC
Communications, Inc.'s Annual Report on Form 10-K for the year ended December
31, 1998 and to all references to our Firm included in this Registration
Statement.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
July 16, 1999
<PAGE> 1
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
MGC Communications, Inc.:
We consent to the use of our report dated August 18, 1997 relating to the
financial statements of MGC Communications, Inc. for the year ended December
31, 1996 included in this registration statement.
KPMG LLP
Las Vegas, Nevada
July 16, 1999
