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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1998 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from
________________________ to____________________________
COMMISSION FILE NUMBER 0-24059
MGC COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEVADA 88-0360042
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(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3301 N. BUFFALO DRIVE, LAS VEGAS, NV 89129
- ------------------------------------------ -----
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(702) 310-1000
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
NONE NONE
---- ----
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of March 15, 1999, the aggregate market value of voting stock held by
non-affiliates of the Registrant, based on the closing sale price of such stock
in the NASDAQ Stock Market on March 15, 1999, was approximately $81,000,000. As
of March 15, 1999, the Registrant had 17,205,614 shares of Common Stock
outstanding.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Documents Incorporated by Reference
--------------------------------------------------
Portions of the Proxy Statement to be used in connection with the solicitation
of proxies to be voted at the Registrant's annual meeting of Stockholders to be
held on May 21, 1999, to be filed with the Commission, are incorporated by
reference into Part III of this Report on Form 10-K.
Exhibit Index is located on page 32
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PART I
ITEM 1. BUSINESS
THE COMPANY
The Company is a rapidly growing integrated communications services
provider, ("ICP") offering switched local and long distance voice and data
services. The Company targets small business and residential users, the largest
segment of the national communications market, based on access lines in service.
The Company began operations in December 1996 in Las Vegas, Nevada as a switched
local exchange service provider. Through internally generated growth the Company
subsequently expanded its network to offer service in Atlanta, Chicago, southern
Florida and selected suburban areas of southern California including the Los
Angeles area and San Diego. As of February 28, 1999, the Company's network
footprint provided access to over 11 million addressable lines. As of December
31, 1998, MGC had 61,205 end user access lines sold, of which 47,744 lines were
in service. During 1999, the Company currently plans to continue expanding its
network by adding over 100 central office collocation sites to the 207 sites
existing at year end 1998.
MGC's network strategy consists of purchasing and deploying switching
equipment, collocating interconnection equipment in incumbent local exchange
carriers ("ILECs'") central offices and leasing fiber optic transmission
capacity from ILECs and other providers of telecommunications transport
services. The Company believes its switch-based network architecture represents
a demand-driven approach requiring less capital deployment than required for the
physical buildout of a fiber optic infrastructure. This architecture also allows
the Company to allocate transport from its collocations to its host switch sites
among various vendors to seek to achieve cost efficiencies. Further, build-out
time frames are minimized allowing the Company to begin offering services in a
market in as little as six months. Management believes the Company's network
architecture has and will continue to enable it to (i) rapidly penetrate and
expand its addressable market, (ii) achieve cost effective network operations
and economies of scale in sales and marketing, (iii) secure a physical presence
for collocation in ILEC central offices before space becomes more difficult to
obtain, (iv) maximize economic returns when compared to total service resale and
other network construction alternatives and (v) take advantage of technology
that facilitates the convergence of voice and data services.
In 1998, the Company deployed a fully digital ATM backbone connecting
its host switch sites in each of its service territories. This backbone provides
for intra-Company transport when applicable, increased transport cost
efficiencies and the digital transport architecture required for data
transmissions. During 1999, the Company plans to introduce a portfolio of high
speed data services for remote Local Area Network ("LAN") and Internet access.
The Company's first data offering is being developed to be a feature-rich,
competitively-priced Internet service marketed as MGCi.com. This product is
expected to be launched during the second quarter of 1999.
The Company also intends to offer a converged voice and data solution to
targeted prospects utilizing digital subscriber line ("xDSL") technology as the
transport mechanism. Customer premise equipment ("CPE"), also known as
integrated access devices will be deployed connecting back to the digital
subscriber line access multiplexers (DSLAMS) located at the Company's
collocation and host switch sites. This equipment will allow the Company to
offer multiple voice connections and dedicated high-speed data transmissions
over a single copper loop or T1 connection. By extending the network
intelligence to the customers' premise, the Company can offer a total
communications solution to small business and residential customers. Management
believes this additional service offering will provide incremental revenue as
well as additional gross margin potential by virtue of not requiring additional
transport costs. The Company recently entered into a purchase agreement with an
equipment vendor to provide the CPE and DSLAM equipment for the initial
deployment in the Las Vegas market.
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BUSINESS STRATEGY
MGC's objective is to become the primary provider of telecommunications
services to its existing and target customers. Key elements of the Company's
strategy include:
Target Small Business and Residential Users. The Company believes the
small business and residential customer base is the largest segment of the
telecommunications market in the United States, based on access lines in
service. The Company is targeting suburban areas of Tier I Markets because these
areas have concentrated numbers of small businesses (3-50 lines), Internet
Service Providers ("ISPs"), pay phone operators, multiple dwelling unit
customers and single family residences. The Company believes its only
significant switch-based competition for these customers in these markets is the
ILEC.
Implement Rapid Service Rollout. The Company's strategy is to address
the greatest percentage of its target market as quickly as possible. To
accomplish this, the Company has accelerated its ILEC central office collocation
program and is rapidly deploying its combined local and long distance switches,
unbundled transport and local loops and data services infrastructure in each of
its markets.
Deploy A Capital Efficient Network. MGC is one of the first ICPs to
utilize a network strategy of purchasing and deploying switches, collocating in
the central offices of the ILEC and leasing the necessary transport. The Company
employs three basic types of transport: (i) unbundled loops which connect a
customer to the Company's collocated facilities in an ILEC central office, (ii)
local transport which connects the Company's collocation equipment to its
switching centers that house its Nortel DMS 500 circuit-based local and long
distance switches and data switching equipment, and (iii) long distance
transport utilizing a dedicated leased ATM backbone which delivers fully
digital, packetized voice from its switching centers to connect its customers'
long distance calls to national and international destinations. Management
believes this network strategy provides for a demand-driven capital deployment
plan that will provide an attractive return on invested capital.
Control Customer Elements of the Network. The Company obtains the
ability to serve its customers through the acquisition of local loop
connections. Upon leasing a line from the ILEC, the Company effectively places
the customer on its network. This connection serves as the platform for
delivering the Company's current and future communication services to the
customer. Any changes to the customer's service profile, including service
enhancements, are under the direct control of the Company, with the exception of
repairs which are infrequent and may require the participation of the ILEC's
network maintenance staff.
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Ensure Timely and Accurate Provisioning Process. The Company believes
one of the keys to its success is effectively managing the provisioning process
so that new customers are transferred from the ILEC's network to the Company's
network in an accurate and timely fashion. The Company has committed significant
time and resources to devising more efficient provisioning processes in each of
its markets. It closely monitors ILEC installation performance to assure
provisioning is in accordance with the standards set forth in the Company's
interconnection agreement with the ILEC. During 1998, the Company developed
electronic bonding capabilities and is currently utilizing various degrees of
electronic order entry with each of the five ILECs with which it does business
in an effort to further improve provisioning performance.
Focus on Targeted Sales and Marketing Effort. The Company's sales
programs include direct sales to business customers, vendor and affinity
programs, direct mail, and targeted advertising, particularly for residential
customers. The Company has both local and national sales personnel for business
customers and has centralized its sales order personnel for residential
customers. The Company's national sales group concentrates on large basic
telephone service users such as multi-dwelling unit owners, customer owned,
coin operated telephones ("COCOTs") operators and ISP customers. The local sales
group solicits small business customers and coordinates activities with
equipment vendors.
Provide Quality Customer Service. The Company utilizes a centralized
team of customer sales and service representatives to coordinate initial
residential inquiries and orders, as well as post-installation, billing and
customer care related issues for all customers. The CSRs are able to leverage
the Company's proprietary management information system to gain immediate access
to the Company's customer data, enabling quick and effective responses to
customer requests and needs at any time. Furthermore, this system permits the
Company to present its customers with one fully integrated monthly billing
statement for all communication services. By having a centralized call service
center operating on a 24 hour per day, seven day a week basis, the Company can
effectively control quality of service and the related training requirements.
Leverage Sophisticated Management Information System. A comprehensive
operations support system is a critical component to managing the Company's
business as well as offering superior customer service. The Company has
installed a fully automated, proprietary management information system designed
to provide comprehensive, integrated features addressing all aspects of its
business, including customer care, billing and collections, general ledger,
payroll, fixed asset tracking, and personnel management. The Company believes
this system is adaptable to changing circumstances and multiple ILEC interfaces,
and is scaleable to support the Company's operations throughout its expected
growth.
Capitalize on Management Expertise. The Company has recruited a team of
experienced business executives with entrepreneurial backgrounds. Maurice J.
Gallagher, Jr., Chairman, has been a founder of a number of start-up businesses,
including ValuJet and BankServ. Nield J. Montgomery, CEO and President, has over
36 years of telephone experience, most recently with ICG Communication, Inc.
Other executives have held senior management positions at major
telecommunications companies, including, among others, Sprint, Centel, NYNEX,
Contel, GTE and MCI.
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PRODUCTS AND SERVICES
During 1998, the Company focused on offering basic telephone services,
including switched local dialtone and enhanced calling features such as voice
mail, call waiting and call forwarding ("basic telephone services"). These
services are required by virtually all users of telecommunications. The Company
also offers long distance services to its local exchange customers in each of
its markets in operation. During 1999, the Company intends to introduce dial-up
Internet service and bundled voice and high-speed data offerings. The Company's
specific product offerings include:
Business Lines
- Single line business (with optional feature packages), Centrex
service, access trunks and customer owned coin operated
telephone lines ("COCOTs").
Residential Lines
- Single and second lines (including multi-dwelling unit lines)
and basic telephone service with optional feature packages.
Long Distance Services
- Outbound 1+.
- Inbound 800/888 and calling cards (expected to be introduced
during the first half of 1999).
Data Services
- Nortel's Internet Thruway product (ISP ports).
- MGCi.com Internet service (expected to be introduced during the
second quarter of 1999).
- Bundled voice and high-speed data via xDSL technology (expected
to be introduced during 1999).
During 1998, the Company contracted for the use of IXC Communications
Inc.'s fiberoptic network on a resale basis to provide long distance services.
The Company offers everyday prices to its customers at $.10 per minute or less
for continental United States direct dial long distance calls and more
attractive rates for customers with greater volumes. Moreover, the Company is
able to bill domestic calls in six second increments. To obtain the Company's
long distance rates, customers have to purchase the Company's switched local
service. The Company believes it can offer competitive long distance rates
because calls originating through the Company's switches eliminate a portion of
the switched access charges. To augment its underlying network flexibility and
gain further transport economies, in the fourth quarter of 1998, the Company
also contracted with Qwest Communications on a resale basis. During 1999, the
Company will continue to explore transport alternatives to seek to assure a
robust network transport at a low cost.
The Company has signed agreements with each ILEC and other carriers in
its markets for the provisioning of number portability, operator and directory
services, 911 services and Yellow Page and White Page listings. Local number
portability (LNP) was implemented in each of the Company's markets during 1998
for customers that desire to retain existing telephone numbers by means of
remote call forwarding mechanisms. Operator services are offered through a major
long distance carrier or ILEC. Emergency 911 services are provisioned through
links to the ILEC switch which, in turn, is connected to a 911 service bureau.
The Company's proprietary management information system updates customer
addresses and immediately supplies them to the appropriate emergency
authorities. In addition, the Company's interconnection agreement with the ILEC
in each of its markets contains a provision requiring the ILEC to list each of
the Company's business customers in the Yellow Pages.
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MARKETS
A key component of the Company's strategy is to concentrate on early
market entry into suburban areas of Tier I Markets. These suburban areas
typically contain large populations of residential and small business, including
COCOT and ISP prospects. The Company currently operates in Las Vegas, Atlanta,
Chicago, southern Florida and selected suburban areas of southern California
including San Diego. These markets were chosen in part because of their
pro-competitive regulatory environments. The Company is currently exploring
expansion possibilities into additional markets in 1999 predicated on capital
availability and other factors.
SALES AND MARKETING
The Company concentrates its sales and marketing efforts on users of
basic telecommunications services. The specific customer groups the Company
targets are:
- Small business customers that typically have between three and
50 lines.
- Single family residential users.
- Customer owned coin operated telephone providers (COCOTs).
- Multi-dwelling unit owners and managers (MDUs).
- Internet Service Providers (ISPs).
The Company's highly focused marketing efforts seek to generate
well-managed, profitable growth through increased market share with minimal
customer churn. The Company's sales programs include direct sales efforts,
agent/vendor programs, telemarketing and targeted advertising.
As of February 28, 1999, the Company employed 51 local sales personnel
and four national sales personnel. Within each local market, the Company expects
to employ approximately ten sales personnel and two sales assistants. The
national sales force is responsible for identifying and soliciting prospective
multi-dwelling unit owners and managers, COCOT and ISP customers. The local
sales personnel solicit small business customers and coordinate activities with
equipment vendors. In the Company's Las Vegas market, telemarketers are assigned
to one or more local sales representatives to generate leads and schedule
appointments and, when practical, to close accounts of five lines or less over
the phone. Sales Assistants act as liaisons between business customers and the
Company's operational personnel to effect coordinated transfers of service from
the ILECs.
To complement its local and national sales representatives, the Company
utilizes established telephone equipment vendors as agents to whom it pays a
commission to sell the Company's local and long distance services in conjunction
with equipment sales to business customers.
Prior to service initiation and during the early stages of each market's
operation, the Company seeks to begin promoting its name and establishing
awareness of its presence through focused public relations activities. To date,
the Company's inauguration of service in each of its existing markets has
generated meaningful publicity in both the print and broadcast media.
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Due to the fact the Company generally initiates service in each market
in a limited area, advertising activities employ geographically specific media
during the early phase of operation in each market. As a result, the Company
uses targeted media such as Cable TV, zoned editions of neighborhood/business
press and radio (on a limited basis) as each new market opens. As a given market
reaches a critical mass of collocation expansion (expected to be within 9 to 12
months after initiation of service), the Company will employ more broad-based
general market media in order to achieve greater cost efficiencies in its
message delivery. These media options include the expanded use of radio and
full-run print publications. Initially, the advertising messages are created to
establish name awareness and credibility for the Company in each new market.
After the initiation of service, the messages are crafted to specifically
promote the Company's service offerings particularly towards the residential
audience. Additionally, the Company works closely with a national directory
clearinghouse to insure timely and accurate placement of its directory
advertising information in each market.
Customer Owned Coin Operated Telephone Providers. The Company has been
successful in targeting the COCOT segment in its markets because (i) the Company
generally offers such customers lower rates compared with the ILEC in each
market, and (ii) the Company provides its COCOT customers a sophisticated
management report that enables them to accurately bill IXCs for dial-around
compensation. The Company believes it is one of the only ICP or CLEC offering
such management reports in its markets. MGC currently has contracts with several
COCOT operators in each of its operational markets.
Multi-Dwelling Unit Owners and Managers. The Company also targets
apartments and multi-dwelling units by offering owners and managers a turn-key
telephone product for its occupants. To initiate such service at an apartment
complex, the Company will initially utilize the ILEC's unbundled loop from each
apartment to the Company's collocated equipment in the ILEC central office. Once
installed, the service will remain active for future tenants. Under the
Company's multi-dwelling unit program, the tenant does not have to arrange for
the service independently, pay deposits (which can be managed through the
deposit process for the apartment) or wait for installation. Additionally,
installation charges may be reduced from traditional amounts charged to
individual customers. After the Company and the apartment complex complete the
initial installation, the apartment owner/manager will be able to offer new
tenants telephone service the day the lease is signed. A call from the apartment
manager or the tenant will provide the necessary customer information to begin
service. Larger complexes (100 or more lines) will allow the Company to
economically install hardware at the apartment site and lease T1 spans to
transport the traffic directly to its switch, bypassing the ILEC's loops.
Internet Service Providers. In conjunction with the introduction of the
Company's ATM backbone, Nortel's Internet Thruway product was introduced to
MGC's ISP customers in February 1998. By replacing the need for data modems, the
Internet Thruway eliminates the need for ISPs to purchase large amounts of
capital equipment to expand their business. The product is sold on a "per port"
basis to the ISP and the technology available with the Internet Thruway allows
an ISP to operate in any of MGC's markets without requiring a physical presence
in such market. Further, the Company has deployed the capability to shift ISP
traffic off its voice network at the point of origin. As a result, the Company
optimizes the voice ports of its DMS-500 switches while providing ISP customers
with a high quality data connection. Additionally, the Company gains access by
contract to the ISP's Internet customer base allowing it to market local and
long distance service to that customer base.
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NETWORK
Network Architecture. MGC has built an exclusively facilities-based
network wherein it purchases and owns the switch and collocation equipment and
leases transport and local loops on an incremental basis, as demand dictates,
from ILECs, CAP/CLECs and other ICPs. As a result, the Company is not burdened
by the operating and financing expenses associated with owning a fiber optic
transport network. By using the ILEC's or other telecommunications services
provider's fiber network interconnecting central offices and loops through
collocation, the Company seeks to reach a broad market of customers for a
fraction of the cost of a constructed fiber network.
The Company believes the traditional copper loop connection from the
ILEC central office to the end user (the "first mile") provides a cost-effective
solution in gaining control of the customer. The Company's cost of the loop to
actually facilitate service is not incurred until the sale event has occurred
and revenue can be generated from the customer. The Company continually
evaluates evolving technologies for cost-effective first mile solutions, and
recently entered into an agreement for the deployment of xDSL based equipment
which will be installed during 1999. This technology will facilitate the
convergence of voice and data services and is expected to provide substantial
transport cost savings as well as providing significant bandwidth improvement
when compared to currently deployed technology. The Company expects that future
additional products and services predicated on bandwidth enhancement will be
delivered via this technology.
The Company believes that it has the ability to lease the necessary
transport at reasonable prices in all its operational markets. Prior to the
passage of the Act in February 1996, ILEC's fiber transport was subject to
tariffs and usually priced substantially higher than a competing CAP/CLEC's.
With the passage of the Act, ILECs were required to lease their network elements
at cost based prices. MGC seeks to find two or three competing transport
suppliers in each of its markets with competitive prices.
In 1996, the Company installed its first Nortel DMS 500 digital switch
in Las Vegas and established collocation facilities in nine Sprint central
offices. Since that time the Company has continued its aggressive network
expansion. By the end of December 1998, the Company had seven operational DMS
500 circuit-based switches and had established over 200 collocation sites. This
network provides the Company access to over 11 million addressable lines as of
December 31, 1998.
The Company's network architecture with its extensive reach through
collocation sites is expected to help facilitate a rapid deployment of xDSL
based equipment during 1999. This equipment will facilitate the convergence of
voice and data services and increase transport economies by carrying voice and
data traffic in packets from the customer premise to the MGC network over a
single access circuit loop rather than the multiple circuits (one to one ratio)
currently required.
Switch Hardware. To date, the Company's circuit-based switching platform
is the Nortel DMS 500. The DMS 500 system offers a flexible and cost effective
means of establishing a single point of presence in, and the ability to provide
revenue generating services to, both the local and long distance services
markets. The DMS 500 combines local switch functionality of the DMS 100 with
long distance toll and tandem switching capability.
The Company's early-to-market strategy includes accelerated
installation into ILEC central office collocation facilities. The Company
believes the expertise it has developed in establishing collocation facilities
will allow it to efficiently handle continued network expansion including the
installation of central office equipment required by the planned deployment of
xDSL technology.
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Interconnection Agreements. The Company has interconnection agreements
with Sprint for operation in Las Vegas, BellSouth in Georgia and Florida, GTE in
California, Pacific Bell ("PacBell") in California and Ameritech Corp.
("Ameritech") in Illinois. These agreements expire on various dates through July
2000. The Company believes it has secured favorable agreements which will allow
it to operate on a cost effective basis in these jurisdictions, but there can be
no assurance that the agreements will be renewed on favorable terms. The Company
has authority to operate as a CLEC in Illinois, Georgia, Nevada, California,
Florida and Massachusetts. The Company will apply for additional CLEC authority
in additional states as deemed necessary to accommodate expansion plans.
OPERATIONS
Customer Service. The Company strives to provide quality customer
service in each of its markets. This includes:
- Personnel. CSRs and sales personnel who are well trained and
attentive to customers' needs. CSRs are available 24 hours a
day, seven days a week, 365 days a year.
- Phones. Prioritizing the response to customer phone calls such
that calls are answered and responded to with minimal wait time.
- Coordination. Coordinating service installation with both the
customer and the ILEC.
- Customer Information. Keeping the customer informed if there is
an installation or repair problem and dedicating the necessary
resources to resolve the problem as soon as possible.
- Billing. Providing the customer a timely bill which is
comprehensive, accurate and simple to read and understand.
Centralization. The Company has a centralized customer service center,
including a centralized call center in Las Vegas, which operates 24 hours a day,
seven days per week. Centralization allows the Company to control personnel and
their training to a greater degree than with call centers in each city and
thereby allowing the Company to provide consistent, high quality customer
service with lower overhead costs.
Automation. The Company believes automation of internal processes
contributes greatly to the overall success of a service provider and billing is
a critical element of any telephone company's operation. The Company's
management information system has been designed to allow a CSR to quickly gather
all the necessary information from a customer in a logical, conversational
manner, establish the appropriate billing and credit information and
electronically process the order with the ILEC for the local loop provisioning.
The system creates the correct emergency 911 address update for new customers
and supplies the required information to the appropriate emergency authorities.
Concurrently, the system will establish the related cost elements with the order
to track the expense of the UNEs leased from the ILEC.
Thereafter, the system will track the progress of the order based on
electronic or facsimile updates from the ILEC. The installation desk will follow
the customer's order, seeking to ensure the installation date is met.
Additionally, CSRs will be able to handle all other customer service inquiries,
including billing questions and repair calls with the information available from
the integrated system.
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In addition, the Company's proprietary management information system has
been designed to track and bill all forms of local service, including line and
feature charges as well as long distance charges. Additionally, the billing
system can provide sophisticated solutions for business customers. Companies
desiring a single bill for many locations, summary bills only without detail or
any other combination can be accommodated. Lastly, the Company is developing the
ability to deliver billing information in a number of alternative media
including electronic files or on-line inquiry.
LOW COST FOCUS
To offer service to its targeted segments of the market and seek to
obtain long term profitability, the Company seeks to create a low cost structure
and focus. The key components of this strategy are:
Low Cost Network Architecture. MGC has chosen to build an exclusively
switch-based network and to lease the necessary transport and local loops on an
incremental basis, as demand dictates, from ILECs, CAP/CLECs and other ICPs. As
a result, the Company will not be burdened by the carrying cost of a constructed
transport network. This approach allows the Company to precisely target its
capital expenditures to the specifics of each market and developing conditions.
Standardized Switch/Installation. For all of its circuit-based switching
applications, the Company plans to use Nortel switches, all configured in the
same manner providing ease of installation and integration into MGC's network.
The Company believes this approach will reduce the time to install its switches.
Automation. An important component in producing a low cost environment
is automation of the processes involved. The Company has installed a proprietary
management information system designed to be a comprehensive, integrated system
that addresses all aspects of its business, including customer care and billing,
general ledger, payroll, fixed asset management, purchasing and personnel. This
system is fully scaleable and has been designed to support the Company's
operation as it grows.
Credit Policy. To minimize its bad debt exposure, the Company has
implemented a policy generally requiring new customers to meet minimum credit
standards or make deposits for specified services and estimated usage prior to
the initiation of services. Management believes the Company's current credit and
deposit policies are in line with and in some instances more conservative than
competing ILECs in its markets. Additional personnel have been dedicated to
collections and credit monitoring to lower the Company's credit exposure.
Efficient Customer Service. The Company has a centralized customer
service center, including a call center located in Las Vegas, which operates 24
hours per day, seven days per week. The centralized calling center handles all
inquiries and orders for new service. This centralization allows the Company to
control personnel and their training to a greater degree than with call centers
in each city.
Voice Over Data. The Company has deployed and is using its ATM data
network to interconnect all its territories. While using this network for data,
the Company is also making internal voice calls through this network. The
packetized voice transmission has been of good quality and the Company plans to
begin transporting interstate long distance calls via this network. The Company
currently expects the transport cost per minute for these calls to be less than
one cent.
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COMPETITION
The Company believes the only significant switch-based competitor for
its targeted markets (small businesses and residential users in suburban areas
of large metropolitan markets) is the ILEC. However, the CAP/CLECs and other
communications suppliers in each of the metropolitan areas in which the Company
operates also compete for the Company's targeted market.
General competition in each of the service categories provided by the
Company is discussed below.
Local Services. In each of its geographic markets, the Company faces
significant competition for the local services it offers from RBOCs and other
ILECs, which currently dominate their local telecommunications markets. These
companies all have long-standing relationships with their customers and have
financial, personnel and technical resources substantially greater than those of
MGC.
The Company also faces competition in most markets in which it does and
will operate from one or more CAP/CLECs or ICP operating fiber optic networks.
Other local service providers have operations or are initiating operations
within one or more of the Company's service areas. MGC expects AT&T (through its
acquisition of Teleport Communications Group, Inc.), WorldCom (through its
acquisition of MCI), Sprint and certain cable television providers, all of which
are substantially larger and have substantially greater financial resources than
the Company, to enter some or all of the markets the Company serves. MGC also
understands other entities have indicated their desire to enter the local
exchange services market within specific metropolitan areas served or targeted
by MGC.
In addition, a continuing trend toward consolidation and strategic
alliances within the communications industry could result in significant new
competition for the Company. AT&T and MCI have begun to enter the local services
market through acquisitions and internal growth. Other potential competitors of
the Company include utility companies, other long distance carriers and wireless
telephone systems. The Company cannot predict the number of competitors that
will emerge as a result of existing or new federal and state regulatory or
legislative actions.
Competition in all of the Company's market areas is based on quality,
reliability, customer service and responsiveness, service features and price.
The Company intends to keep its prices at levels below those of the ILECs while
providing, in the opinion of the Company, a higher level of service and
responsiveness to its customers. Innovative packaging and pricing of basic
telephone services is expected to provide competitive differentiation for the
Company in each of its markets.
Although the ILECs are generally subject to greater pricing and
regulatory constraints than other local network service providers, ILECs are
achieving increasing pricing flexibility for their local services as a result of
recent legislative and regulatory developments. The ILECs have continued to
lower rates, resulting in downward pressure on prices for certain services.
Long Distance Services. The Company competes with AT&T, MCI Worldcom,
Sprint and a host of other second and third tier providers in the long distance
services market. Many of the Company's competitors have long-standing
relationships with their customers and have financial, personnel and technical
resources substantially greater than those of MGC. In providing these services,
the Company will focus on quality service and low cost to distinguish itself in
a very competitive marketplace. In addition, the Company may face additional
competitive challenges if the price of long distance minutes falls as a result
of decreased access charges. The Company believes the introduction of its ATM
backbone and Internet Thruway products will enable it to compete for ISP traffic
on the basis of the quality and low cost of its services; however, the market
for such ISP traffic is extremely competitive.
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GOVERNMENT REGULATIONS
Overview. The Company's services are subject to varying degrees of
federal, state and local regulation. The FCC exercises jurisdiction over all
facilities of, and services offered by, telecommunications common carriers such
as the Company, to the extent those facilities are used to provide, originate or
terminate interstate or international communications. The state regulatory
commissions retain some jurisdiction over most of the same facilities and
services to the extent they are used to originate or terminate intrastate
communications. In addition, many of the regulations issued by these regulatory
bodies may be subject to judicial review, the result of which the Company is
unable to predict.
Federal Regulation. The Company must comply with the requirements of
common carriage under the Communications Act of 1934 (the "Communications Act"),
as amended. Comprehensive amendments to the Communications Act were made by the
Act, which was signed into law on February 8, 1996. The Act effected plenary
changes in regulation at both the federal and state levels that affect virtually
every segment of the telecommunications industry. The stated purpose of the Act
is to promote competition in all areas of telecommunications and to reduce
unnecessary regulation to the greatest extent possible. While it will take years
for the industry to feel the full impact of the Act, it is already clear the
legislation provides the Company with both opportunities and challenges.
The Act gives the FCC the authority to forebear from regulating
companies if it finds such regulation does not serve the public interest, and
directs the FCC to review its regulations for continued relevance on a regular
basis. As a result of this directive, a number of the regulations that
historically applied to IXCs have been and may continue to be eliminated in the
future. While it is therefore expected that a number of regulations that were
developed prior to the Act will be eliminated in time, certain of those which
apply to the Company at present are discussed below.
Pursuant to the Communications Act, the Company is subject to the
general requirement that its charges and regulations for communications services
must be "just and reasonable" and that it may not make any "unjust or
unreasonable discrimination" in its charges or regulations.
The FCC has established different levels of regulation for dominant and
non-dominant carriers. Of domestic common carrier service providers, only GTE,
the RBOCs and other ILECs are classified as dominant carriers, and all other
providers of domestic common carrier services, including the Company, are
classified as non-dominant carriers. The Act provides the FCC with the authority
to forebear from imposing any regulations it deems unnecessary, including
requiring non-dominant carriers to file tariffs. On November 1, 1996, in its
first major exercise of regulatory forbearance authority granted by the Act, the
FCC issued an order detariffing domestic interexchange services. The order
required mandatory detariffing and gave carriers such as the Company nine months
to withdraw federal tariffs and move to contractual relationships with its
customers. This order subsequently was stayed by a federal appeals court. Until
further action is taken by the FCC or the courts, the Company will continue to
maintain tariffs for these services.
Although the FCC does not directly regulate local exchange service,
which is within the jurisdiction of state regulatory authorities, its actions
may impact directly on such service. The Act greatly expands the FCC's
interconnection requirements on the ILECs. The Act requires the ILECs to: (i)
provide physical collocation, which allows companies such as MGC and other
interconnectors to install and maintain their own network termination equipment
in ILEC central offices, and virtual collocation only if requested or if
physical collocation is demonstrated to be technically unfeasible, (ii) unbundle
components of their local service networks so other providers of local service
can compete for a wider range of local services customers, (iii) establish
"wholesale" rates for their services to promote resale by CLECs and other
competitors, (iv) establish number portability, which will
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allow a customer to retain its existing phone number if it switches from the
ILEC to a competitive local service provider, (v) establish dialing parity,
which ensures customers will not detect a quality difference in dialing
telephone numbers or accessing operators or emergency services, and (vi) provide
nondiscriminatory access to telephone poles, ducts, conduits and rights-of-way.
In addition, the Act requires ILECs to compensate competitive carriers for
traffic originated by the ILECs and terminated on the competitive carrier's
networks. The FCC is charged with establishing national guidelines to implement
the Act. The FCC issued its Interconnection Order on August 8, 1996, which
established detailed rules regarding rates, terms and conditions for
interconnection between CLECs and ILECs. The Interconnection Order was appealed
to the U.S. Court of Appeals for the Eighth Circuit. On July 18, 1997, the Court
issued a decision vacating the interconnection pricing rules and "most favored
nation" rules as well as certain other interconnection rules. On January 25,
1999, the Supreme Court substantially overturned the Eighth Circuit, holding
that the FCC had pricing jurisdiction over unbundled network elements, and
establishing the ability of a CLEC to "pick and choose" among the most
favorable terms from the existing agreements of other CLECs. The Supreme Court
also required the FCC to determine those unbundled network elements which are
available to competitors under the "necessary and impair" standard. While the
full impact of this decision cannot be measured at this time, the Company
believes that it will have no negative impact on its operations.
As a result of provisions of the Act, the Company has taken the steps
necessary to be a provider of local exchange services. MGC has obtained CLEC
certification in six states. In addition, the Company has successfully
negotiated interconnection agreements with five ILECs. Certain rates in these
interconnection agreements have been established by the Federal Communications
Commission (FCC) and are subject to adjustment upon final negotiations. The
Company has recorded UNE expenses related to Sprint (Nevada) using management's
best estimate of the probable outcome for the final negotiated rates. These
rates are less than the FCC established rates, however management believes the
resolution of this matter will not have an adverse effect on the Company's
financial position, results of operations, or liquidity.
The Act's interconnection requirements also apply to interexchange
carriers and all other providers of telecommunications services, although the
terms and conditions for interconnection provided by these carriers are not
regulated as strictly as interconnection provided by the ILECs. This may provide
the Company with the ability to reduce its own access costs by interconnecting
directly with non-ILECs, but may also cause the Company to incur additional
administrative and regulatory expenses in replying to interconnection requests
from other carriers.
On May 16, 1997, the FCC released an order that fundamentally
restructured the "access charges" ILECs charge to interexchange carriers and end
user customers. The Company's analysis of the FCC's order leads it to believe
the FCC's new access charge rules do not adversely affect the Company's business
plan, and they do in fact present significant opportunities for new entrants,
including the Company. Aspects of the order may be changed and to the extent
access charges may be reduced in the future, competitors will have an increased
ability to offer low cost long distance services. Numerous parties have asked
the FCC to reconsider portions of its new rules.
As part of its pro-competitive policies, the Act may free the RBOCs from
the judicial order that prohibited their provision of interLATA services.
Specifically, the Act permits RBOCs to provide long distance services outside
their local service regions immediately, and will permit them to provide
in-region interLATA service upon demonstrating to the FCC and state regulatory
agencies they have adhered to the FCC's interconnection regulations. Many ILECs
have filed applications for in-region long distance authority none of which have
been granted by the FCC as of March 15, 1999. At least two of these decisions
have been appealed. Additional applications are being filed and will be
considered by the FCC. The FCC is also considering an RBOC proposal to permit
RBOCs to eventually offer high speed, interLATA data services within their
operating regions through a separate subsidiary, without first having to
demonstrate
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that they have met the FCC interconnection regulations discussed above. Two
RBOCs, US West and Ameritech, entered into "teaming agreements" with Qwest
Communications International, Inc. ("Qwest"), whereby the RBOCs would solicit
customers for Qwest's long distance service and handle billing of those
customers in exchange for a fee. These agreements would have permitted the RBOCs
to offer their local customers a package of local and long distance services in
competition with the Company's offerings even though the RBOCs would not
themselves be providing the long distance component. The Company and certain
IXCs requested the FCC to block the proposed arrangement and initiated
litigation in federal courts. 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 holding that these
agreements were an improper attempt by the RBOCs to provide interLATA service
that would be inconsistent with the Telecommunications Act. The FCC's decision
has been appealed to the federal courts.
While the Act reduces regulation to which non-dominant local exchange
carriers are subject, it also reduces the level of regulation that applies to
the ILECs and increases their ability to respond quickly to competition from the
Company and others. For example, in accordance with the Act, the FCC has applied
"streamlined" tariff regulation to the ILECs which greatly accelerates the time
required for changes to tariffed service rates to take effect and eliminates the
requirement that ILECs obtain FCC authorization before constructing new domestic
facilities. These actions will allow ILECs to change service rates more quickly
in response to competition. Similarly, the FCC is considering proposals that may
provide significant new pricing flexibility to ILECs. To the extent such
increased pricing flexibility is provided, the Company's ability to compete with
ILECs for certain service may be adversely affected.
On May 8, 1997, in compliance with the requirements of the Act, the FCC
released an order establishing a new Universal Service support fund, which
provides subsidies to carriers that provide service to under-served individuals
and customers in high cost areas, and to companies that provide
telecommunications services and wiring for schools and libraries. The Company is
required to contribute into the Universal Service support fund, but may also be
eligible to obtain subsidies for services it provides. The new Universal Service
rules will be administered jointly by the FCC and state regulatory authorities,
many of which are still in the process of establishing their administrative
rules. The net financial effect of these regulations on the Company cannot be
determined at this time.
State Regulation. The Company has satisfied state requirements to
provide CLEC and intrastate long distance service in Nevada, Georgia, Illinois,
California, Florida and Massachusetts. State authorizations vary in their
regulatory intensity. State laws and regulations that prohibit, or have the
effect of prohibiting, local and intrastate long distance telecommunications
competition have been preempted under the Act. Although the Act's prohibition of
state barriers to competitive entry took effect on February 8, 1996, various
legal and policy matters must be resolved before the Act's policies are fully
implemented. The Company continues to support efforts at the state government
level to encourage competition in its markets under the federal law and to
permit CLECs to operate on the same basis and with the same rights as the ILECs.
In most states, the Company is required to file tariffs setting forth
the terms, conditions, and prices for services which are classified as
intrastate. In some states, the Company's tariff can list a range of prices for
particular services and in others such prices can be set on an individual
customer basis. The Company is not at this time subject to price cap or to rate
of return regulation in any of its current or planned expansion markets.
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Local Government Authorizations. The Company may be required to obtain
from municipal authorities construction permits to construct its facilities in
certain cities.
In some of the areas where the Company provides service, it may be
subject to municipal franchise requirements and may be required to pay license
or franchise fees based on a percentage of gross revenue or other formula. There
are no assurances that certain municipalities that do not currently impose fees
will not seek to impose fees in the future, nor is there any assurance that,
following the expiration of existing franchises, fees will remain at their
current levels.
PERSONNEL
As of February 28, 1999, there were 453 employees of the Company, the
majority of whom were located in Las Vegas. The Company expects to substantially
increase its employee count as it focuses on selling into the network footprint
that was established during 1998 and as it continues to expand its market reach
in 1999.
MGC has non-disclosure and non-compete agreements with all of its
executive employees. None of MGC's employees is represented by a collective
bargaining agreement.
RISK FACTORS
LIMITED OPERATING HISTORY
The Company began providing local telephone services in December 1996 in
Nevada. Since then, the Company began providing local telephone services in
Atlanta, Chicago, southern Florida and selected suburban areas of Southern
California including the Los Angeles area and San Diego and began offering long
distance services in February 1998. To date, substantially all of the Company's
revenues have come from such services. The Company expects to continue to
increase the size of its operations in the future.
Although many of the Company's managerial and supervisory personnel have
substantial experience in the telecommunications industry, the Company has a
very limited operating history. As a result, there is limited historical
financial information about the Company upon which to base an evaluation of the
Company's future prospects or performance. Furthermore, no historical basis
exists for estimating the number of customers or the amount of revenues the
Company's operations will generate or for determining whether the Company will
compete successfully in the telecommunications industry.
RISKS DUE TO DEBT
As of December 31, 1998, the Company had approximately $157.3 million
total outstanding debt. The Company's level of indebtedness could have important
consequences to investors, including the following:
- A substantial portion of the Company's cash flow from operations
will be dedicated to paying principal and interest on its debt,
thereby reducing funds available for other purposes.
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- The Company's significant amount of debt could make the Company
more vulnerable to changes in general economic conditions or
increases in prevailing interest rates.
- The Company's ability to obtain additional financing for working
capital, capital expenditures, acquisitions, general corporate
purposes or other purposes could be impaired.
- The Company may be more leveraged than certain of its
competitors, which may result in a competitive disadvantage.
The Company recorded net losses of $32.1 million and $10.8 million in
1998 and 1997, respectively. The Company anticipates that earnings will be
insufficient to cover fixed charges through 1999. In order for the Company to
meet its debt service obligations, the Company will need to substantially
improve its operating results. The Company cannot assure investors that it will
achieve or sustain profitability or positive EBITDA in the future or that its
operating results will be sufficient for the Company to meet its debt service
obligations. In the absence of such operating results, the Company could face
substantial liquidity problems and might be required to seek additional
financing through the issuance of debt or equity securities. However, the
Company could be unsuccessful in obtaining such financing on favorable terms
when needed.
CAPITAL REQUIREMENTS
The development and expansion of the Company's business and services and
the development of new markets and products will require significant capital as
well as considerable operational and administrative expenditures. A substantial
portion of such expenditures are incurred before the realization of revenues,
resulting in negative cash flow until an adequate customer base is established.
Although its revenues have increased since its inception, the Company has
incurred significant increases in expenses due to the expansion of its services
and customer base.
The Company expects to fund its capital requirements through existing
resources, debt or equity financing and internally generated funds. The Company
expects that continued expansion of its business may require raising substantial
additional equity and/or debt capital. However, the Company might not be
successful in raising sufficient debt or equity capital on acceptable terms. In
addition, the Company's future capital requirements will depend upon a number of
factors, including marketing expenses, staffing levels and customer growth, as
well as other factors that are not within the Company's control, such as
competitive conditions, government regulation and capital costs. Failure to
generate or otherwise access sufficient funds may require the Company to delay
or abandon some of its future expansion or capital expenditures, which would
have a negative impact on its growth and its ability to compete in the
telecommunications industry.
RISKS ASSOCIATED WITH IMPLEMENTATION OF GROWTH STRATEGY
The development and expansion of the Company's business and its entry
into new markets will depend on, among other things, the Company's ability to
achieve the following goals in a timely manner, at reasonable costs and on
satisfactory terms and conditions:
- Accurately assess potential new markets
- Purchase, install and operate switches and other equipment
- Negotiate suitable interconnection and collocation arrangements
with ILECs on satisfactory terms and conditions
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- Identify, hire and retain qualified personnel
- Lease access to suitable transport networks
- Obtain government authorizations
The Company has experienced rapid growth since its inception, and
management believes that sustained growth will place a strain on operational,
human and financial resources. The Company's ability to manage its expansion
effectively will also depend on the continued development of plans, systems and
controls for its operational, financial and management needs. Because of its
limited operating history, the Company may be unable to satisfy these
requirements or otherwise manage its growth effectively. Any failure to satisfy
these requirements could have a negative effect on the Company's financial
condition and its ability to fully implement its expansion plans.
LACK OF NEW SERVICE ACCEPTANCE BY CUSTOMERS
While CLECs have had some success inducing business customers to utilize
an alternative local exchange provider, the Company believes it is currently the
only integrated communications provider targeting residential customers in its
markets. The success of the Company will be dependent upon the willingness of
such customers to accept the Company as an alternative provider of local, long
distance, data and Internet service. The lack of such acceptance could have a
negative effect on the Company.
PRODUCTS AND SERVICES
To date, the Company has offered only local and long distance
telecommunications services. In order to address the needs of its target
customers, the Company is in the process of developing additional products and
services, such as high speed data services and Internet services. However, the
Company might not be able to provide the range of telecommunication services
that its target customers need or desire. Furthermore, the Company cannot assure
investors that its new product offerings will be attractive to its existing and
prospective customers.
TECHNOLOGY, EQUIPMENT AND INTERCONNECTION RISKS
An essential element of the Company's current strategy is the
provisioning of switched local telephone service. In implementing its strategy,
the Company may use new or existing technologies in new applications. During the
testing of this equipment, the Company may experience technological problems
that cannot be resolved. Expansion is also dependent on the ability to obtain
collocation space, which is obtained from the ILECs on a first come/first served
basis.
The Company cannot assure investors that installation of the switches
and associated electronics will continue to be completed on a timely basis, nor
can the Company assure investors that it will be able to obtain collocation
sites in the markets it desires. In addition, the development and expansion of
the Company's business and its entry into new markets will be dependent on,
among other things, its ability to lease or purchase suitable sites, obtain
equipment on a timely basis, obtain sufficient blocks of telephone numbers and
negotiate suitable interconnection and collocation arrangements with ILECs on
satisfactory terms. These factors and others could adversely affect the
expansion of the Company's customer base and commencement of operations in new
markets. If the Company is not able to expand its customer base or enter new
markets in accordance with its plans, the growth of its business would be
negatively affected.
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RELIANCE ON THIRD PARTIES
Because a key element of its business and growth strategy is the leasing
of transport capacity, the Company is dependent upon the cooperation of other
companies (known as "ILECs" and "CAP/CLECs") whose fiber optic networks and
local loops are leased by the Company. As such, the Company leases from and
relies upon its competitors. This carries considerable risks, including the
following:
- The Company must negotiate and renew favorable interconnection
and collocation agreements with other companies. The rates
charged to the Company under the interconnection agreements
might not continue to be low enough for the Company to attract a
sufficient number of customers and to operate the business on a
profitable basis. In certain cases, the rates that have been or
will be charged to the Company are subject to regulatory
proceedings, the result of which the Company is unable to
accurately predict.
- The Company relies on the timeliness of other companies (ILECs
and CAP/CLECs) which process the Company's orders for customers
switching to the Company's service and for the maintenance of
unbundled network elements ("UNEs") in order to assure
uninterrupted service. The ILECs have had little experience in
providing UNEs to other companies. Therefore, the ILECs might
not be able to continue to provide and maintain the UNEs in a
prompt and efficient manner.
- The Company's interconnection agreements currently provide for
the Company's connection and maintenance orders to receive
attention at parity with the ILEC's or other CAP/CLEC's
customers and for the ILEC to provide adequate trunking capacity
to keep blockage within industry standards. However, the ILECs
might not continue to comply with their network provisioning
requirements. From time to time, in Las Vegas, the Company has
experienced excessive blockage in the delivery of calls from the
ILEC to the Company's switches due to inadequate trunk
provisioning by the ILEC. Blocked calls result in customer
dissatisfaction which may result in the loss of Company
business.
RISKS DUE TO TECHNOLOGY: POTENTIAL SYSTEM OR SECURITY FAILURE
The Company's success in marketing its services to business and
residential users requires the Company to provide reliable service. The
Company's networks are subject to 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 the Company's customers. Interruptions in
service, capacity limitations or security breaches could have a negative effect
on customer acceptance and, therefore, on the Company's business, financial
condition and results of operations.
RAPID TECHNOLOGICAL CHANGES
The telecommunications industry is subject to rapid and significant
changes in technology. While the Company believes that for the foreseeable
future these changes will not materially affect or hinder the Company's ability
to acquire necessary technologies, the Company cannot predict the effect of
technological changes on its business. Thus, technological developments could
negatively affect the Company.
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FURTHER GROWTH RISKS -- QUALIFIED PERSONNEL
The Company's ability to manage its expansion effectively will require
it to continue to implement and improve its operational and financial systems
and to expand, train and manage its employee base. The Company's growth will
increase the operating complexity of the Company as well as the level of
responsibility for both existing and new management personnel. The Company
believes that its future success will depend in large part on its continued
ability to attract and retain highly skilled and qualified personnel.
The Company's business is managed by a small number of key management
and operating personnel, whose loss could have a negative impact on the
Company's business. None of the Company's key executives is a party to a
long-term employment agreement with the Company. Furthermore, the Company does
not maintain key man insurance on its officers. The Company's inability to
effectively expand, train and manage its employee base could have a negative
effect on its business.
RISKS ASSOCIATED WITH AUTOMATION
The Company employs a proprietary management information system which is
expected to be an important factor in its success. If the management information
system fails or is unable to perform as expected, it would have a substantial
adverse effect on the Company. 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.
RISKS RELATED TO INTERNET SERVICES
Maintenance of Peering Relationships. The Internet is comprised of many
Internet service providers and underlying transport carriers who operate their
own networks and interconnect with other Internet service providers at various
points. As the Company commences the operation of Internet services, transport
will be provided via wholesale carriers. The Company anticipates that as volume
increases related to its Internet traffic, peering agreements will be entered
into for the exchange of traffic with other Internet service providers.
Peering relationships with other Internet service providers will permit
the Company to exchange traffic with other Internet service providers without
incurring settlement charges. Although the Company intends to meet the
industry's current standards for peering, there is no guarantee that other
national Internet service providers will maintain peering relationships with
MGC. In addition, the requirements associated with maintaining peering
relationships with the major national Internet service providers may change. The
Company cannot provide assurance that it will be able to expand or adapt its
network infrastructure to meet any new requirements on a timely basis, at a
reasonable cost, or at all.
Potential Liability of On-Line Service Providers. 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 for materials carried on or
disseminated through their systems is imposed on Internet service providers, the
Company would likely implement measures to minimize its exposure to such
liability. Such measures could require the Company to expend substantial
resources or discontinue certain product or service offerings. In addition,
increased attention on liability issues, as a result of litigation, legislation
or legislative proposals could adversely affect the growth and use of Internet
services.
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CONTROL OF THE COMPANY
As of March 15, 1999, Maurice J. Gallagher, Jr., Nield J. Montgomery,
Timothy P. Flynn and Robert L. and Carol A. Priddy owned, directly or
indirectly, in the aggregate, approximately 34.5% of the outstanding Common
Stock and voting power of the Company. Accordingly, such stockholders
collectively will likely be able to control the management policy of the
Company, decide all fundamental corporate actions, including mergers,
substantial acquisitions and dispositions, and elect the Board of Directors of
the Company.
COMPETITION
The Company believes that various legislative initiatives, including the
Telecommunications Act of 1996, have removed barriers to local telephone service
competition. Nevertheless, in light of the passage of the Telecommunications
Act, regulators are also likely to provide ILECs with increased pricing
flexibility as competition increases. If ILECs are permitted to lower their
rates substantially or engage in excessive volume or term discount pricing
practices, the net income or cash flow of the Company could be materially
adversely affected.
In its existing markets and the markets into which it intends to expand,
the Company faces significant competition for its local telephone services.
ILECs have long-standing relationships with their customers, which relationships
may create competitive barriers. Furthermore, ILECs may have the potential to
subsidize competitive service from monopoly service revenues. A continuing trend
toward business combinations and alliances in the telecommunications industry
may create larger, more powerful competitors.
The Company also faces competition in the markets in which it operates
from one or more CAP/CLECs operating fiber optic networks. Many of the Company's
existing and potential competitors have financial, personnel and other resources
significantly greater than those of the Company.
The Company competes with AT&T, MCI Worldcom, Sprint and others in the
long distance services market. Additionally, recent federal legislation permits
the Regional Bell Operating Companies ("RBOCs") to provide long distance
services once certain criteria are met. Once the RBOCs begin to provide such
services, they will be in a position to offer single source service similar to
the service the Company offers. In addition, several interexchange carriers have
announced their intention to enter the local exchange services market, which is
facilitated by the Act's resale and unbundled network element provisions. The
Company cannot predict the number of competitors that will emerge as a result of
existing or new federal and state regulatory or legislative actions, but
increased competition from the RBOCs with respect to long distance services or
from IXC's with respect to local exchange services could have a material adverse
effect on the Company's business.
COMPETITION FOR DATA/INTERNET CUSTOMERS
In its markets for data products and services, specifically those
directed at Internet Service Providers and end-users of Internet products and
services, the Company will face competition from a number of companies focused
on the data services market, including companies with significantly greater
financial resources, greater name recognition, more extensive business
experience and greater market and service capabilities than the Company. In
particular, the Company will be required to compete with companies that design
and manufacture products exclusively for this market and large system
integrators. Substantially all
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of the Company's current and prospective competitors in the data services market
have substantially greater market presence and financial, technical, marketing
and other resources than the Company.
COMPETITIVE REACTION
Although the Company generally offers rates for its services which are
below those currently charged by ILECs, ILECs or new competitors with greater
capital and resources than the Company may meet or undercut the Company's price
structure and prevent the Company from attaining the share of the local
telecommunications market necessary to achieve profitable operations. The
Company's ability to meet price competition may depend on its ability to operate
at costs equal to or lower than its competitors or potential competitors. There
is a risk that competitors, perceiving the Company to lack capital resources,
may undercut the Company's rates or increase their services in an effort to
force the Company out of business. Competitors may also attempt to place their
existing customer base under long-term contractual agreements which may inhibit
the Company's ability to convert these users to its services. In addition, the
success of the Company will ultimately depend on management's ability to react
expeditiously and effectively to exigencies that have not been taken into
account in the Company's business plan.
REGULATION
The Company is subject to varying degrees of federal, state and local
regulation. The Company is not currently subject to price cap or rate of return
regulation, nor is it currently required to obtain FCC authorization for the
installation, acquisition or operation of its network facilities. The Company is
generally subject to certification and tariff or price list filing requirements
for intrastate services by state regulators. Although passage of the
Telecommunications Act should result in increased opportunities for companies
competing with the ILECs, changes in current or future regulations adopted by
the FCC or state regulators or other legislative or judicial initiatives
relating to the telecommunications industry could have an adverse effect on the
Company.
Furthermore, while the Telecommunications Act reduces regulations to
which non-dominant local exchange carriers are subject, it also reduces the
level of regulation that applies to the ILECs and increases their ability to
respond quickly to competition from the Company and others. In addition,
although the Telecommunications Act provides incentives to ILECs to negotiate
interconnection agreements with local competitors, there can be no assurance
these ILECs will negotiate quickly with competitors such as the Company for the
required interconnection of the competitor's networks with those of the ILECs or
that interconnection agreements will be on terms favorable to the Company.
For a further discussion on the effects of Governmental regulation on
the Company see "Business - Government Regulations" in Item 1 of this Annual
Report.
RISKS OF FUTURE ACQUISITIONS
The Company may acquire other businesses as a means of expanding into
new markets or developing new services. The Company is unable to predict whether
or when any prospective acquisitions will occur or the likelihood of such a
transaction being completed on favorable terms and conditions. Such transactions
involve certain risks including, but not limited to: (1) difficulties
assimilating acquired operations and personnel, (2) potential disruptions of the
Company's ongoing business, (3) the diversion of resources
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and management time, (4) the possibility that uniform standards, controls,
procedures and policies may not be maintained, (5) risks associated with
entering new markets in which the Company has little or no experience, and (6)
the potential impairment of relationships with employees or customers as a
result of changes in management. Any business the Company might acquire might
not perform as expected.
YEAR 2000 RISK
For a discussion of certain risks presented by the ability of the
Company and others on whom the Company relies to successfully make their
computer systems Year 2000 compliant, see "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Impact of Year 2000" in Item
7 of this Annual Report.
LACK OF DIVIDEND HISTORY
The Company has never declared or paid any cash dividends on its Common
Stock and does not expect to declare any such dividends in the foreseeable
future. Payment of any future dividends will depend upon the earnings and
capital requirements of the Company, the Company's debt facilities and other
factors the Board of Directors considers appropriate. The Company intends to
retain its earnings, if any, to finance the development and expansion of its
business. Furthermore, the Company's ability to declare and pay cash dividends
on its Common Stock is restricted by certain covenants in the Indenture relating
to the Company's 13% Senior Secured Notes due 2004 (the "Senior Secured Notes").
FORWARD LOOKING STATEMENTS
Certain statements contained in this Report that state the Company's or
management's intentions, hopes, beliefs, expectations or predictions of the
future are forward-looking statements. Management wishes to caution the reader
these forward-looking statements such as the Company's plans to expand its
existing network through collocation, statements regarding development,
introduction and acceptance of the Company's products or business, statements
regarding the Company's ability to achieve or exceed its goals or reach
profitability in the future, statements regarding the adequacy or availability
of financing, statements regarding the outcome of regulatory proceedings or the
effect of government regulations or similar statements contained in this Report
regarding matters that are not historical facts, are only estimates or
predictions. Actual results may differ materially as a result of risks facing
the Company or actual results differing from assumptions underlying such
statements. 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 and renew
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 regulatory, legislative and
judicial developments that could materially affect the Company's future results.
All forward-looking statements made in this Report are expressly qualified in
their entirety by these cautionary statements.
22
<PAGE> 23
ITEM 2. PROPERTY
In Las Vegas, the Company has a five year lease (expiring in 2001) with
a five year option for the site housing its switch. In addition, the Company
leases space in Las Vegas for its corporate headquarters, national customer
service operations, national sales personnel, Las Vegas sales personnel and
general administration. This lease expires in 2003. This facility is owned by a
limited liability company which is principally owned by two of the Company's
principal stockholders and Directors, Maurice J. Gallagher, Jr. and Timothy P.
Flynn.
The Company owns premises housing its switch facilities in its Ontario,
Chicago, Long Beach, San Diego and Fort Lauderdale locations. The switch site in
Atlanta has been leased for a term expiring in 2007 with certain renewal
options. Facilities housing the local sales and administration staff have been
leased in each market.
The Company places great importance on each switch facility and seeks to
insure maximum security and environmental control. MGC believes this can be
achieved through standalone structures. This approach minimizes the risk of fire
or other hazards from adjacent tenants or properties.
ITEM 3. LEGAL PROCEEDINGS
The Company has filed various complaints against ILECs in order to seek
to enforce their compliance with regulations requiring their cooperation with
the provision of service by the Company. These complaints have been filed
against Sprint Corporation in February and June 1998 before the Nevada Public
Utilities Commission, Ameritech in March 1998 before the Illinois Commerce
Commission, and BellSouth Telecommunications Inc. in June 1998 before the
Georgia Public Service Commission.
The Company is also currently participating in costing dockets before
the Nevada Public Utilities Commission and California Public Utilities
Commission under which there will be established the amount payable by the
Company for its unbundled network elements ("UNEs"). Although rates for UNEs are
subject to change from time to time, the establishment of rates by the
respective public utilities commissions could have a material effect on the
Company's cost of revenues.
From time to time, the Company is engaged in other litigation and
governmental proceedings in the ordinary course of its business. The Company
does not believe that any such pending litigation or governmental proceedings
will have a material adverse effect on its results of operation or financial
condition.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
23
<PAGE> 24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock, $.001 par value, is traded on the NASDAQ
Stock Market under the symbol "MGCX." As of March 15, 1999, there were
approximately 164 holders of record of the Company's Common Stock. The following
sets forth the reported high and low sale prices for the Common Stock for each
fiscal quarter since the Company's Common Stock first commenced trading on May
11, 1998.
<TABLE>
<CAPTION>
Fiscal year ended
December 31, 1998 High Low
----------------- ------ ------
<S> <C> <C>
May 11, 1998 through June 30, 1998 $19.56 $14.00
Quarter Ending September 30, 1998 $17.93 $ 8.00
Quarter Ending December 31, 1998 $10.50 $ 5.25
</TABLE>
As of March 15, 1999 the closing price of the common stock was $8.25.
DIVIDENDS
No cash dividends have ever been declared by the Company on its Common
Stock. The Company intends to retain earnings to finance the development and
growth of its business. Accordingly, the Company does not anticipate that any
dividends will be declared on its Common Stock for the foreseeable future.
Future payments of cash dividends, if any, will depend on the Company's
financial condition, results of operations, business conditions, capital
requirements, restrictions contained in agreements, future prospects and other
factors deemed relevant by the Company's Board of Directors. The Company's
ability to declare and pay dividends on its Common Stock is restricted by
certain covenants in the Indenture governing the Senior Secured Notes.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS EXCEPT
PER SHARE DATA)
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Operating revenues $ 18,249 $ 3,791 $ 1
Net loss (32,065) (10,836) (1,491)
Basic and diluted loss per
share of common stock* (2.26) (1.30) (2.11)
Total assets 252,119 191,977 12,339
Long-term debt including current maturities 157,295 156,637 --
Redeemable Series A Convertible Preferred Stock -- 16,665 --
</TABLE>
* See Note 1 of Notes to Financial Statements
24
<PAGE> 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
MGC began providing competitive local exchange services to small
business and residential users in December 1996, and in February 1998, began
offering long distance services in its existing markets. MGC's network strategy
consists of purchasing and deploying switching equipment, collocating equipment
in the incumbent local exchange carriers' (ILEC) central offices and leasing
fiber optic transmission capacity from ILECs and other providers of
communications transport services. Currently, the Company has switches fully
operational in Las Vegas, Atlanta, Chicago, Southern Florida, and in selected
suburban areas of Southern California, including the Los Angeles area and San
Diego.
The Company's 1997 revenues were generated from sales of
telecommunications services consisting primarily of local phone service,
switched access billings and non-recurring charges, principally installation
charges. In 1998, long distance services also contributed to the Company's
revenue base.
The Company's principal operating expenses consist of cost of operating
revenues, selling, general and administrative costs and depreciation and
amortization expense. Cost of operating revenues consists primarily of access
charges, line installation expenses, transport expenses, compensation expenses
of technical personnel, long distance expenses and central office facility
rentals. Selling, general and administrative expenses consist primarily of
compensation expenses, advertising, provision for bad debts, professional fees
and facility rentals. Depreciation and amortization expense includes
depreciation on switching and collocation equipment as well as general property
and equipment.
During 1998, the Company 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, significant levels of marketing activity were
incurred in new markets in order for the Company to build its initial base of
customers.
The development and expansion of the Company's business has required and
will continue to require significant capital expenditures primarily consisting
of the purchase of communications switching and associated equipment, the
purchase of land for switching sites and the construction of buildings or
leasehold improvements to switching and collocation facilities. As part of its
"smart build" network strategy, the Company purchased and installed host
switches in each of its markets while leasing transport and unbundled networks
elements (UNEs) from the ILEC and other CLECs. The Company believes this
facilities-based strategy, while initially increasing its level of capital
expenditures and operating losses, will enhance its long-term financial
performance in comparison to a resale strategy.
The Company has experienced operating losses and generated negative
EBITDA since inception and expects to continue to generate negative EBITDA
through the 1999 fiscal year while it continues to expand its networks and
develop its product offerings and customer base. There can be no assurance the
Company's revenue or customer base will grow or that the Company will be able to
achieve or sustain positive EBITDA.
25
<PAGE> 26
RESULTS OF OPERATIONS
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
379% 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. The Company provided telecommunications services in only
Las Vegas until December, 1997 when service was initiated in Atlanta and the
Inland Empire region of Southern California. As a result of the network
expansion, service was also offered in Chicago as well as additional suburban
areas of Southern California, including San Diego during 1998. The Company 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 338% 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 the
Company's network.
For the year ended December 31, 1998, selling, general and
administrative expenses totaled $17.9 million a 180% increase over the $6.4
million for the year ended December 31, 1997. The increase in expenses resulted
from increased costs attributable to the marketing of the Company's services,
delivery of customer service and to support the Company's continued network
expansion.
For the 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 in accordance with the Company's planned build-out of its network. As of
December 31, 1998 the Company had seven operational switches and 207 collocation
sites built out as compared to three switches and 25 collocation 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 issued by the Company 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 Senior Secured Notes in September 1997 and with the proceeds from the sale of
the Company's common and Preferred Stock.
The Company incurred net losses of $32.1 million and $10.8 million
during the 1998 and 1997 fiscal years, respectively.
YEAR ENDED DECEMBER 31, 1996
The Company's operations prior to December 1996 were limited to start-up
activities and, as a result, the Company's revenues and expenditures for the
period were not indicative of anticipated revenues which may be attained or
expenditures which may be incurred by the Company in future periods. The Company
did not begin revenue-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.
26
<PAGE> 27
During the year ended December 31, 1996, the Company generated $1,000 in
operating revenues as a result of commencing service during the month of
December. The Company had cost of operating revenues of $0.3 million which
represents primarily fixed costs. In addition, the Company incurred other
operating expenses, including depreciation and amortization, of $1.3 million in
connection with the commencement of operations and the build-out of its 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.
The Company earned interest income in the period of $0.1 million.
As a result, the Company 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 the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations require substantial capital investment for the
purchase of telecommunications equipment and the development and installation of
the Company's network. Capital expenditures for the years ended December 31,
1998 and 1997 were $97.0 million and $22.6 million, respectively. The Company
expects it will continue to have substantial capital requirements in connection
with the purchase of equipment necessary for continued expansion of its network
footprint in its existing markets, and the development of new products and
services. In addition, the Company is currently evaluating possible expansion
into new markets during 1999. Management expects capital expenditures of
approximately $40.0 million for fiscal year 1999, which will be funded by cash
on hand and investments available-for-sale that were generated through the
private sales of debt and equity securities as well as through its initial
public offering of common stock. In addition, the Company is currently
evaluating financing proposals from vendor and equipment lease financing
companies. Should this financing be available on acceptable terms, the Company
may consider accelerating its growth plans and expanding its product offerings.
From its inception through its initial public offering (IPO), the
Company raised approximately $17.9 million from private sales of Common Stock.
In September 1997, the Company completed a $160.0 million offering of
Senior Secured Notes and warrants to purchase 862,923 shares of common stock
(after giving effect to certain anti-dilution adjustments). At the closing of
the sale of the Senior Secured Notes, the Company used approximately $56.8
million of the net proceeds from the sale of the Senior Secured Notes to
purchase a portfolio of securities that has been pledged as security to cover
the first six interest payments on the Senior Secured Notes. The Company used
approximately $3.1 million of the net proceeds to pay accounts payable incurred
in connection with the acquisition of equipment. In addition, the Company has
granted the holders of the Senior Secured Notes a security interest in a
substantial portion of the Company's telecommunications equipment.
In November 1997 and January 1998, the Company issued an aggregate of
6,571,427 shares of Series A Convertible Preferred Stock at $3.50 per share for
net proceeds of $21.6 million. In May 1998, the shares of Series A Convertible
Preferred Stock were converted into 3,942,856 shares of common stock
simultaneously with the Company's initial public offering.
27
<PAGE> 28
The Company's Registration Statement on Form S-1 relating to the sale of
common stock was declared effective by the Securities and Exchange Commission on
May 11, 1998. A total of 4,025,000 shares were sold resulting in net proceeds to
the Company of $63.0 million. In connection with the initial public offering of
the Company's common stock, the Company effected a six for ten reverse stock
split. In addition to the stock split, the Company's outstanding shares of
Preferred Stock were converted into common stock.
The substantial capital investment required to initiate the Company's
services and the funding of the Company's initial operations has resulted in
negative investing and operating cash flow since the Company's inception. This
negative cash flow from operations is a result of the need to establish the
Company's network in anticipation of connecting revenue-generating customers.
The Company expects to continue recording negative cash flow from operations
throughout the 1999 fiscal year due to continued network expansion activities.
There can be no assurance the Company will attain break-even cash flow from
operations in subsequent periods. Until sufficient cash flow from operations is
generated, the Company will be required to utilize its current and future
capital resources to meet its cash flow requirements and may be required to
issue additional debt and/or equity securities. Based upon its current business
plan, the Company does not expect to require additional financing; however,
there can be no assurance the Company will not require additional financing, or
as to the availability or the terms of any such financing. Moreover, the
indenture governing the Senior Secured Notes imposes certain restrictions upon
the Company's ability to incur additional indebtedness or issue preferred stock.
IMPACT OF YEAR 2000
The Year 2000 issue, commonly referred to as Y2K, is rooted in the way
computer systems have been set up to handle the computation of dates. In many
cases, where a date is used in computer code, a two digit field has been used to
indicate 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.
MGC has been focused on Year 2000 issues since its inception in 1996. In
recognition of the priority associated with the Year 2000 issue, the Company has
established a Year 2000 Project Team at the corporate level to lead the Year
2000 effort. Since the Company is young, much of the hardware and software
currently in place was purchased with Y2K readiness
28
<PAGE> 29
in mind. The Company's Y2K plans include a number of phases designed to evaluate
and prepare for readiness by June 1999.
The Company has completed the inventory and assessment of all network
and information system elements and has begun the renovation and testing phases.
The Company's mission critical components, including the telecommunications
network and systems which execute processes such as service assurance, access
management, service delivery, customer service and billing, are targeted for
Year 2000 compliance by June, 1999. Integration testing will continue throughout
the remainder of 1999. Subject to additional compliance testing, the Company
believes that its essential processes, systems and business functions will be
ready for the 1999 to Year 2000 transition.
The Company has received assurance from its significant vendors
including its major telecommunications equipment supplier that their
applications are Year 2000 compliant. Maintenance or modification costs
associated with making changes, if needed, will be expensed as incurred.
The Company's business relies in part on third parties. The ability of
third parties upon whom the Company relies to adequately address their Year 2000
issue is outside the Company's control. However, the Company is coordinating
efforts with these parties to minimize the extent to which its business will be
vulnerable to their failure to remediate their own Year 2000 issues. There can
be no assurance that the systems of the third parties will be modified on a
timely basis. The Company's business, financial condition and results of
operations could be materially adversely affected by the failure of those
systems and applications, licensed to or operated for third parties, or operated
by other parties to properly operate on dates beyond 1999.
The Company is currently in the process of developing contingency plans
should certain mission critical systems fail as a result of Y2K issues. The
Company is also participating in industry wide efforts to address Year 2000
issues with the goal of developing contingency plans addressing not only the
Company's issues but also those of the telecommunications industry as a whole.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. SFAS No. 130 requires companies to classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity sections of a statement of
financial position and is effective for financial statements issued for fiscal
years beginning after December 15, 1997. The Company has adopted SFAS No. 130
for 1998 as reported 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
29
<PAGE> 30
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities." SOP 98-5 requires start-up costs, as defined, to be expensed as
incurred and is effective for financial statements for fiscal years beginning
after December 15, 1998. The Company currently expenses all start-up costs as
incurred and the application of SOP 98-5 will have no material impact on the
Company's financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All the Company's long term debt bears fixed interest rates, however,
the fair market value of this debt is sensitive to changes in prevailing
interest rates. The Company runs the risk that market rates will decline and the
required payments will exceed those based on the current market rate. The
Company does not use interest rate derivative instruments to manage its exposure
to interest rate changes.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted as a separate section of this
Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
MGC did not re-elect KPMG LLP ("KPMG") as its independent accountants on
February 6, 1998. KPMG's report on the Company's financial statements for the
years ended December 31, 1996 and 1995, did not contain an adverse opinion or a
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principles. The decision to change accountants was approved
by the Company's Board of Directors. During KPMG's engagement with the Company,
there were no disagreements with KPMG on any matter of accounting principles or
practices, financial statement disclosure or auditing scope or procedure which
were not resolved to KPMG's satisfaction. During KPMG's engagement with the
Company, there were no reportable events (as defined in Item 304(a)(1)(v) of
Regulation S-K issued under the Securities Act of 1933, as amended).
As of February 6, 1998, Arthur Andersen LLP has been retained by the
Company as its principal accountants to audit the Company's financial statements
for the years ended December 31, 1998 and 1997. The Company had not consulted
Arthur Andersen LLP prior to its engagement regarding the application of
accounting principles to a specified transaction, either completed or proposed,
the type of audit opinion that might be rendered on the Company's financial
statements or any matter that was either the subject of a disagreement with KPMG
or a reportable event.
30
<PAGE> 31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by
reference to the data under the heading "ELECTION OF DIRECTORS" in the Proxy
Statement to be used in connection with the solicitation of proxies for the
Company's annual meeting of Stockholders to be held May 21, 1999, which Proxy
Statement is to be filed with the Commission.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the data under the heading "EXECUTIVE COMPENSATION" in the Proxy
Statement to be used in connection with the solicitation of proxies for the
Company's annual meeting of Stockholders to be held May 21, 1999, which Proxy
Statement is to be filed with the Commission.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the data under the heading "STOCK OWNERSHIP" in the Proxy Statement
to be used in connection with the solicitation of proxies for the Company's
annual meeting of Stockholders to be held May 21, 1999, which Proxy Statement is
to be filed with the Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by
reference to the data under the heading "CERTAIN TRANSACTIONS" in the Proxy
Statement to be used in connection with the solicitation of proxies for the
Company's annual meeting of Stockholders to be held May 21, 1999, which Proxy
Statement is to be filed with the Commission.
31
<PAGE> 32
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)
1. The response to this portion of Item 14 is submitted as
a separate section of this report.
2. The response to this portion of Item 14 is submitted as
a separate section of this report.
3. Filing of Exhibits:
Exhibit 10.24 - First Amendment to Lease with Cheyenne
Investments LLC
Exhibit 10.25 - Second Amendment to Lease with Cheyenne
Investments LLC
Exhibit 21 - Subsidiaries of the Registrant
Exhibit 23.1 - Consent of Arthur Andersen LLP
Exhibit 23.2 - Consent of KPMG LLP
Exhibit 27 - Financial Data Schedule
(b) The Registrant did not file any current report on Form 8-K for the
fourth quarter 1998.
(c) The following exhibits are filed herewith or incorporated by
reference as indicated. Exhibit numbers refer to Item 60l of Regulation S-K.
EXHIBIT NO. AND DESCRIPTION
<TABLE>
<S> <C>
3.1 Articles of Incorporation and Amendments.(1)
3.2 By-laws.(1)
3.3 Stockholders Agreement dated as of November 26, 1997, among the Company,
Maurice J. Gallagher, Jr., Nield J. Montgomery and certain investors
identified therein.(1)
4.1 See the Articles of Incorporation and amendments filed as Exhibit 3.1,
the By-laws filed as Exhibit 3.2 and the Stockholders Agreement filed as
Exhibit 3.3.
4.2 Certificate of MGC Communications, Inc. of the Rights, Preferences,
Privileges and Restrictions of Series A Preferred Stock.(1)
4.3 Indenture dated as of September 29, 1997, between the Company and Marine
Midland Bank, as Trustee.(1)
4.4 Registration Rights Agreement dated as of September 29, 1997, among the
Company, Bear, Stearns & Co. Inc. and Furman Selz LLC.(1)
4.5 Security Agreement dated as of September 29, 1997, between the Company
and Marine Midland Bank.(1)
4.6 Collateral Pledge and Security Agreement dated as of September 29, 1997,
between the Company and Marine Midland Bank.(1)
10.1 Network Products Purchase Agreement dated May 21, 1997, between the
Company and Northern Telecom, Inc. (1) The Commission has granted
confidential treatment with respect to certain portions of this
Agreement.
10.2 Employment/Stock Repurchase Agreement dated as of June 1996 between the
Company and Nield J. Montgomery, as amended as of September 1,
1997.(1)(3)
10.3 Employment and Stock Repurchase Agreement dated May 28, 1997, between
the Company and John Boersma.(1)(3)
10.4 Stock Purchase Agreement dated August 29, 1997, between the Company
Mitchell Allee.(1)
10.5 Stock Option Plan.(1)(3)
10.6 Purchase Agreement dated September 24, 1997, among the Company, Bear,
Stearns & Co. Inc. and Furman Selz LLC.(1)
</TABLE>
32
<PAGE> 33
EXHIBIT NO. AND DESCRIPTION
<TABLE>
<S> <C>
10.7 Warrant Agreement dated September 29, 1997, between the Company and
Marine Midland Bank.(1)
10.8 Warrant Registration Rights Agreement dated as of September 29, 1997,
among the Company, Bear, Stearns & Co. Inc. and Furman Selz LLC.(1)
10.9 Private Placement Bank Escrow Agreement dated September 1997 among the
Company, Bear, Stearns & Co. Inc. and certain investors identified
therein.(1)
10.10 Standard Office Lease Agreement dated July 1, 1997, between the Company
and Cheyenne Investments L.L.C.(1)
10.11 Securities Purchase Agreement dated as of November 26, 1997, among the
Company and the investors identified therein.(1)
10.12 Securities Purchase Agreement dated as of January 8, 1998, among the
Company and the investors identified therein.(2)
10.13 Employment/Stock Repurchase Agreement dated March 20, 1998 between
Michael Burke and the Company.(1)(3)
10.14 Employment/Stock Repurchase Agreement dated March 20, 1998 between David
Clark and the Company.(1)(3)
10.15 Employment/Stock Repurchase Agreement dated March 20, 1998 between Kent
Heyman and the Company.(1)(3)
10.16 Employment/Stock Repurchase Agreement dated March 9, 1998 between James
J. Hurley III and the Company.(1)(3)
10.17 Employment/Stock Repurchase Agreement dated March 20, 1998 between
Thomas Keough and the Company.(1)(3)
10.18 Employment/Stock Repurchase Agreement dated February 16, 1998 between
James D. Mitchell and the Company.(1)(3)
10.19 Employment/Stock Repurchase Agreement dated March 20, 1998 between Carol
Mittwede and the Company.(1)(3)
10.20 Employment/Stock Repurchase Agreement dated March 20, 1998 between Mark
Peterson and the Company.(1)(3)
10.21 Employment/Stock Repurchase Agreement dated March 20, 1998 between David
Rahm and the Company.(1)(3)
10.22 Employment/Stock Repurchase Agreement dated February 11, 1998 between
Walter Rusak and the Company.(1)(3)
10.23 Employment/Stock Repurchase Agreement dated March 20, 1998 between Linda
M. Sunbury and the Company.(1)(3)
10.24 First Amendment to Lease dated May 1, 1998 between Cheyenne Investments,
LLC and the Company.
10.25 Second Amendment to Lease dated December 29, 1998 between Cheyenne
Investments, LLC and the Company.
21 Subsidiaries of the Registrant
23.1 Consent of Arthur Andersen LLP
23.2 Consent of KPMG LLP
27 Financial Data Schedule
</TABLE>
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-4 (File No. 333-38875) previously filed with the Commission.
(2) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (File No. 333-49085) previously filed with the Commission.
(3) Management contract or compensation plan or agreement required to be
filed as an Exhibit to this Report on Form 10-K pursuant to Item 14 (C)
of Form 10-K.
All schedules have been omitted as they are not required under the
related instructions, are inapplicable, or because the information
required is included in the consolidated financial statements or related
notes thereto.
33
<PAGE> 34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MGC COMMUNICATIONS, INC.
By /s/ Nield J. Montgomery
Nield J. Montgomery, President and
Chief Executive Officer
Date: March 23, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
<TABLE>
<S> <C>
/s/ Nield J. Montgomery March 23, 1999
Nield J. Montgomery, President (Chief
Executive Officer) and Director
/s/ Linda M. Sunbury March 23, 1999
Linda M. Sunbury, Vice President (Chief
Financial Officer and Principal
Accounting Officer)
/s/ Maurice J. Gallagher, Jr. March 23, 1999
Maurice J. Gallagher, Jr. Director
(Chairman of the Board)
/s/ Timothy P. Flynn March 23, 1999
Timothy P. Flynn, Director
/s/ Jack L. Hancock March 23, 1999
Jack L. Hancock, Director
March __, 1999
David Kronfeld, Director
March __, 1999
Thomas Neustaetter, Director
</TABLE>
34
<PAGE> 35
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 December 31, 1998 and 1997 F-4
Consolidated Statements of Operations for the years ended December 31, 1998,
1997 and 1996 F-5
Consolidated Statements of Redeemable Preferred Stock and Stockholders'
Equity for the years ended December 31, 1998, 1997 and 1996 F-6
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996 F-7
Notes to Consolidated Financial Statements F-8
</TABLE>
F-1
<PAGE> 36
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> 37
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> 38
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 11,886 $ 45,054
Investments held-to-maturity -- 7,797
Investments available-for-sale 9,851 --
Restricted investments 20,797 18,482
Accounts receivable, less allowance for doubtful
accounts of $257 and $216 at December 31, 1998 and
1997, respectively 6,360 1,200
Prepaid expenses 208 277
--------- ---------
Total current assets 49,102 72,810
Property and equipment, net 116,380 24,617
Investments held-to-maturity -- 49,913
Investments available-for-sale 63,212 --
Restricted investments 18,582 39,092
Deferred financing costs, net of accumulated amortization of
$1,065 and $198 as of December 31, 1998 and 1997, respectively 4,714 5,448
Other assets 129 97
--------- ---------
Total assets $ 252,119 $ 191,977
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 332 $ 381
Accounts payable:
Trade 5,314 462
Property and equipment 18,577 3,123
Accrued interest 5,200 5,328
Accrued other expenses 2,473 786
--------- ---------
Total current liabilities 31,896 10,080
Senior Secured Notes, net of unamortized discount of
$3,307 and $3,882 at December 31, 1998 and 1997,
respectively 156,693 156,118
Other long-term debt 270 138
--------- ---------
Total liabilities 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, 17,190,428 and 8,799,600 shares issued
and outstanding 17 9
Additional paid-in capital 108,991 22,118
Accumulated deficit (44,392) (12,463)
--------- ---------
64,616 9,664
Accumulated other comprehensive income 817 --
Notes receivable from stockholders for issuance of
common stock (2,173) (688)
--------- ---------
Total stockholders' equity 63,260 8,976
--------- ---------
Total liabilities, redeemable preferred stock and
stockholders' equity $ 252,119 $ 191,977
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 39
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Telecommunication services:
Operating revenues $ 18,249 $ 3,791 $ 1
------------ ------------ ------------
Operating expenses:
Cost of operating revenues
(excluding depreciation) 17,129 3,928 305
Selling, general and administrative 17,877 6,440 841
Depreciation and amortization 5,238 1,274 54
Write-off of purchased software -- -- 355
------------ ------------ ------------
40,244 11,642 1,555
------------ ------------ ------------
Loss from operations (21,995) (7,851) (1,554)
Other income (expense):
Gain on sale of investments 223 -- --
Interest income 8,771 2,507 63
Interest expense
(net of amount capitalized) (19,064) (5,492) --
------------ ------------ ------------
Net loss (32,065) (10,836) (1,491)
Accrued preferred stock dividend -- (136) --
Net loss applicable to common
stockholders $ (32,065) $ (10,972) $ (1,491)
============ ============ ============
Basic and diluted loss per
share of common stock $ (2.26) $ (1.30) $ (2.11)
============ ============ ============
Basic and diluted weighted average
shares outstanding 14,178,729 8,458,991 707,359
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 40
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
REDEEMABLE PREFERRED STOCK COMMON STOCK
------------------------------------- ----------------------------
SHARES AMOUNT SHARES AMOUNT
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996............ -- $ -- 240,000 $ --
Common stock issued for services
contributed by stockholder.......... -- -- 480,000 1
Common stock issued for cash.......... -- -- 6,456,000 6
Net loss.............................. -- -- -- --
---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1996.......... -- -- 7,176,000 7
Common stock issued for cash.......... -- -- 1,458,600 2
Common stock issued for notes
receivable.......................... -- -- 165,000 --
Proceeds from offering allocated
to warrants......................... -- -- -- --
Warrants issued for common stock
commitment.......................... -- -- -- --
Net loss.............................. -- -- -- --
8% Series A Convertible Preferred
Stock issued for cash............... 5,148,570 16,665 -- --
Accrued preferred stock
dividend............................ -- -- -- --
---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1997.......... 5,148,570 16,665 8,799,600 9
Common stock issued for cash.......... -- -- 100,680 --
Common stock issued for notes
receivable.......................... -- -- 189,000 --
Warrants and options exercised
for common stock.................... -- -- 133,309 --
8% Series A Convertible Preferred
Stock issued for cash............... 1,422,857 4,980 -- --
Accrued preferred stock dividend...... -- -- -- --
Common stock issued for cash (IPO).... -- -- 4,025,000 4
Conversion of preferred stock to
common stock....................... (6,571,427) (21,645) 3,942,839 4
Unrealized gain on investments
available for sale................. -- -- -- --
Net loss.............................. -- -- -- --
---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1998.......... -- $ -- 17,190,428 $ 17
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
NOTES
RECEIVABLE FROM ACCUMULATED
ADDITIONAL STOCKHOLDERS FOR OTHER TOTAL
PAID-IN ACCUMULATED ISSUANCE OF COMPREHENSIVE STOCKHOLDERS'
CAPITAL DEFICIT COMMON STOCK INCOME EQUITY
---------- ----------- ---------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996............. $ 1 $ -- $ -- $ -- $ 1
Common stock issued for services
contributed by stockholder........... 1 -- -- -- 2
Common stock issued for cash........... 12,274 -- -- -- 12,280
Net loss............................... -- (1,491) -- -- (1,491)
---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1996........... 12,276 (1,491) -- -- 10,792
Common stock issued for cash........... 4,860 -- -- -- 4,862
Common stock issued for notes
receivable........................... 688 -- (688) -- --
Proceeds from offering allocated
to warrants.......................... 3,885 -- -- -- 3,885
Warrants issued for common stock
commitment........................... 409 -- -- -- 409
Net loss............................... -- (10,836) -- -- (10,836)
8% Series A Convertible Preferred
Stock issued for cash................ -- -- -- -- --
Accrued preferred stock
dividend............................. -- (136) -- -- (136)
---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1997........... 22,118 (12,463) (688) -- 8,976
Common stock issued for cash........... 774 -- -- -- 774
Common stock issued for notes
receivable........................... 1,485 -- (1,485) -- --
Warrants and options exercised
for common stock..................... 14 -- -- -- 14
8% Series A Convertible Preferred
Stock issued for cash................ -- -- -- -- --
Accrued preferred stock dividend....... -- (654) -- -- (654)
Common stock issued for cash (IPO)..... 62,959 -- -- -- 62,963
Conversion of preferred stock to
common stock........................ 21,461 790 -- -- 22,435
Unrealized gain on investments
available for sale.................. -- -- -- 817 817
Net loss............................... -- (32,065) -- -- (32,065)
---------- ---------- ---------- ---------- ----------
BALANCE AT DECEMBER 31, 1998........... $ 108,991 $ (44,392) $ (2,173) $ 817 $ 63,260
========== ========== ========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 41
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (32,065) $ (10,836) $ (1,491)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 5,238 1,274 54
Gain on sale of investments 223 -- --
Write-off of purchased software -- -- 355
Amortization of debt discount 575 144 --
Amortization of deferred debt financing costs 867 198 --
Stock issued for services rendered -- -- 2
Changes in assets and liabilities:
Increase in accounts receivable, net (5,160) (1,190) (9)
Decrease (increase) in prepaid expenses 69 (254) (23)
Increase in other assets (32) (91) (5)
Increase in accounts payable-- trade 4,852 386 76
Increase in accrued expenses 1,695 5,879 99
--------- --------- ---------
Net cash used in operating activities (23,738) (4,490) (942)
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net of payables (81,597) (20,207) (2,287)
Purchase of investments held-to-maturity -- (57,710) --
Purchase of investments available-for-sale, net (14,759) -- --
Sale (purchase) of restricted investments 18,195 (57,574) --
--------- --------- ---------
Net cash used in investing activities (78,161) (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) (5,237) --
Proceeds from issuance of 8% Series A convertible
preferred stock, net of issuance costs 4,980 16,665 --
Proceeds from issuance of warrants -- 3,885 --
Proceeds (payments) on other long term debt, net 133 (164) --
Proceeds from issuance of common stock 788 6,015 11,126
Proceeds from issuance of common stock (IPO) 62,963 -- --
--------- --------- ---------
Net cash provided by financing activities 68,731 177,138 11,126
--------- --------- ---------
Net (decrease) increase in cash (33,168) 37,157 7,897
Cash and cash equivalents at beginning of period 45,054 7,897 --
--------- --------- ---------
Cash and cash equivalents at the end of period $ 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 payable -- property and equipment $ 15,454 $ 1,751 $ 1,372
========= ========= =========
Notes payable issued for property and equipment $ 50 $ 683 $ --
========= ========= =========
Stock issued for notes receivable $ 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 $ 19,192 $ 164 $ --
========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 42
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(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 subsidiary, MGC Lease Corporation. 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 suburban areas of southern
California including San Diego with substantially all of its operating revenues
being derived from the Las Vegas, Ontario, and Atlanta operations.
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 years ended December 31, 1998, 1997 and 1996, the Company
has recognized in operating revenues switched access revenues of approximately
$7,378,000, $730,000 and $0, respectively. Included in trade accounts receivable
in the accompanying balance sheets as of December 31, 1998 and 1997 are
receivables related to switched access of approximately $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.
ADVERTISING COSTS
The Company expenses advertising costs in the period incurred. As of
December 31, 1998, 1997 and 1996 the Company had expensed advertising costs of
$810,000, $125,000 and $0, respectively.
INVESTMENTS
F-8
<PAGE> 43
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 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.
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
F-9
<PAGE> 44
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 to regulatory agreements that govern the rates to be charged to the
Company.
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.
F-10
<PAGE> 45
(2) PLAN OF OPERATIONS
In September 1997, the Company completed an offering of 160,000 units
consisting of $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. The
Company expects to continue its expansion and development of services into new
markets. The Company expects to fund its capital requirements through existing
resources, debt or equity financing and internally generated funds.
Management recognizes that 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 that the
Company will be successful in raising additional capital, achieving profitable
results, or entering into new markets.
Management also recognizes that 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 regulatory, legislative and
judicial developments that could materially affect the Company's future results.
(3) PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Building and property $ 2,653 $ 278
Switching equipment 57,045 21,621
Leasehold improvements 740 956
Computer hardware and software 2,218 1,404
Office equipment and vehicles 901 300
--------- ---------
63,557 24,559
Less accumulated depreciation and amortization (6,555) (1,317)
--------- ---------
57,002 23,242
Switching equipment under construction 59,378 1,375
--------- ---------
Net property and equipment $ 116,380 $ 24,617
========= =========
</TABLE>
F-11
<PAGE> 46
(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>
Maturities of long-term debt for each of the next five years ending
December 31, consist of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
1999 $ 332
2000 174
2001 96
2002 --
2003 --
2004 156,693
--------
$157,295
========
</TABLE>
In September 1997, the Company completed an offering for 160,000 units
consisting of $160 million of 13% Senior Secured Notes due in 2004 and warrants
to purchase 774,720 shares of common stock (collectively the "Offering").
The Notes bear interest at the rate of 13% per annum, payable
semi-annually in arrears on April 1 and October 1, commencing April 1, 1998. As
set forth in the Indenture pursuant to which the Notes were issued the Company
is required to hold in a trust account sufficient funds to provide for payment
in full of interest on the Notes through October 1, 2000. The accompanying
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 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 Offering proceeds to the warrants based on a value of $4.68 per
share of common stock less the exercise price of $.02 per share for the warrant.
The warrants are exercisable at any time on or after the earlier to
occur of (i) October 1, 1998, or (ii) the date on which a change in control
occurs. The agreement pursuant to which the warrants were issued required an
anti-dilution adjustment if the preferred stock offering was consummated at a
price less than $5.00 per share. As further discussed in Note 5, the Company
completed the preferred stock offering for $3.50 per share. Accordingly, the
warrants issued in connection with the Offering were increased from 774,200 to
862,923 and have been reflected in the accompanying consolidated financial
statements as of December 31, 1998 and 1997. Expenses
F-12
<PAGE> 47
allocated to the warrants in connection with the Offering were $141,000. The
warrants expire on October 1, 2004.
In conjunction with the Offering, certain persons deposited an aggregate
of $15.0 million in escrow (the Common Stock Commitment), which funds were to
have been applied to the purchase of shares of Common Stock in the event the
Company failed to sell at least $15.0 million of preferred stock within a
certain period of time. Since sufficient preferred stock was issued within the
time period, the investors received a return of their funds contributed to
escrow. As a commitment fee for the Common Stock Commitment, the Company issued
to all such persons contributing to the escrow funds warrants to purchase an
aggregate of 90,000 shares of Common Stock at $.02 per share.
The Company has recorded the commitment fee as non-cash consideration in
connection with the Offering. The value of the warrants issued as a commitment
fee was determined based on a value of the Company's common stock at $4.68 per
share less the exercise price of $.02 per share for the warrant. All such
warrants were exercised in January and February 1998.
The Notes may be redeemed at the option of the Company, in whole or in
part, on or after October 1, 2001, at a premium declining to par in 2003, plus
accrued and unpaid interest and liquidated damages, if any, through the
redemption date as follows:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- ---- ----------
<S> <C>
2001 106.50
2002 103.25
2003 and thereafter 100.00
</TABLE>
In the event of a sale by the Company prior to October 1, 2000 of its
capital stock in one or more equity offerings, up to a maximum of 35% of the
aggregate principal amount of the Notes originally issued will, at the option of
the Company, be redeemed from the net cash proceeds at a redemption price equal
to 113% of the principal amount, plus accrued and unpaid interest and liquidated
damages, if any, to the redemption date, provided at least 65% of the aggregate
principal amount of Notes originally issued remain outstanding immediately after
the occurrence of such redemption. As of the date of these 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, acquire
an aggregate of more than 20 Switches until consolidated earnings before
interest, taxes, depreciation and amortization (EBITDA) is positive for two
consecutive quarters (with certain exceptions), engage in sale and lease back
transactions, create certain liens, enter into certain transactions with
affiliates, sell assets of the Company or its restricted subsidiaries, conduct
certain lines of business, issue or sell equity interests of the Company's
restricted subsidiaries or enter into certain mergers and consolidations. As of
December 31, 1998, management believes it is in compliance with all debt
covenants.
In conjunction with the Offering, the authorized capital stock of the
Company was increased to 60,000,000 shares of common stock, $.001 par value per
share, and 50,000,000 shares of preferred stock, $.001 par value per share.
F-13
<PAGE> 48
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.
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 (the "LLC") was formed for the purpose of
funding the development stage of MGC Communications, Inc. In June 1996, the
Company and LLC entered into an agreement whereby LLC would acquire 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
F-14
<PAGE> 49
$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. The $1,485,000 owed
to the Company is classified in the accompanying consolidated statements of
redeemable preferred stock and stockholders' equity as notes receivable from
stockholders for issuance of common stock.
During May and June 1998, the Company sold 4,025,000 shares of common
stock at $17.00 per share pursuant to the registration statement filed on Form
S-1, which was declared effective by the Securities and Exchange Commission on
May 11, 1998. In connection with the initial public offering of the Company's
common stock, the Company effected a six for ten reverse stock split, which has
been reflected in the accompanying financial statements. In addition to the
reverse stock split, the Company's 6,571,427 outstanding shares of Preferred
Stock (as defined below) were converted to 3,942,839 shares of the Company's
common stock upon completion of the initial public offering. The conversion of
the 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 (the "Preferred Stock").
In November 1997, the Company completed a private placement offering in
which 5,148,570 shares of the Preferred Stock were issued at $3.50 per share,
for total proceeds to the Company of approximately $16.7 million, net of
expenses.
In January 1998, the Company completed an additional private placement
offering in which 1,422,857 shares of Preferred Stock were issued at $3.50 per
share for total proceeds to the Company of approximately $5.0 million, net of
expenses. The terms of the offering were substantially identical to those of the
previous preferred stock offering.
Each share of Preferred Stock was automatically converted into common
stock on a six for ten basis upon the consummation of the Company's IPO. In
accordance with the terms of the Preferred Stock, the accrued dividends were
reversed at the time of conversion.
(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 reserved shares of the Company's common stock under the MGC
Communications, Inc. Stock Option Plan.
F-15
<PAGE> 50
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.
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 fair
value of each option is estimated on the date of grant using the Black-Scholes
option pricing model with 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 each of the options issued during the
years ended December 31, 1997 and 1996, substantially all of which have been
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>
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
RANGE OF AT REMAINING AVERAGE AT AVERAGE
EXERCISE DEC. 31, CONTRACTUAL EXERCISE DEC. 31, 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>
The Company applied Accounting Principles Board (APB) 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
cost 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.
F-16
<PAGE> 51
(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.
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.
(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 or better than
the terms which would be available from an unaffiliated lessor.
F-17
<PAGE> 52
Future minimum lease obligations in effect as of December 31, 1998 are as
follows (in thousands):
Payments during the year ending December 31:
<TABLE>
<S> <C>
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 December 31,
1998, the Company had a total for all vendors of approximately $15.4 million of
remaining purchase commitments for purchases of switching equipment.
LITIGATION
The Company is a 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 sales related to the
Sprint (Nevada) interconnection agreement at amounts which are management's best
estimates of the probable outcome of the final negotiated rates, which are less
than the FCC established rates. The difference, which totals approximately $1.7
million and $1.1 million at 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 financial position, results of operations, or liquidity.
F-18
<PAGE> 53
(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 management information computer system. Management believes the
terms and conditions of this agreement are equal to the terms which would be
available from an unaffiliated party.
F-19
<PAGE> 1
EXHIBIT 10.24
FIRST AMENDMENT TO LEASE
This First Amendment to Lease is attached to and made a part of that certain
Lease dated July 01, 1997 by and between Cheyenne Investments, LLC, a Nevada
Limited Liability Company, ("Landlord" and MGC Communications, Inc., a Nevada
Corporation ("Tenant").
The above mentioned Lease is amended as follows:
PREMISES
1) The number Thirty Two Thousand, Four Hundred Fifty square feet (32,450) of
Rentable area is hereby substituted for the number Twenty Four Thousand,
One Hundred Twenty Five square feet (24,125) of Rentable area as found in
Paragraph 2,(1).
BASE MONTHLY RENT
2) The sum Fifty Three Thousand Five Hundred Forty Two and 50/100 Dollars
($53,542.50) is hereby substituted for the sum Thirty Nine Thousand Eight
Hundred Six and 25/100 Dollars ($39,806.25) as found in Paragraph 2,(j).
Save and except as amended hereby, said Lease shall remain unmodified and in
full force and effect.
IN WITNESS WHEREOF, Landlord and Tenant have signed this First Amendment to
Lease this 1st day of May, 1998.
LANDLORD: TENANT:
Cheyenne Investments, LLC MGC Communications, Inc.
A Limited Liability Company A Nevada Corporation
By: /s/ GEORGE K. CONNOR /s/ NIELD J. MONTGOMERY
- ------------------------------- -------------------------------
Title: Manager Title: President
------------------------ ------------------------
<PAGE> 1
EXHIBIT 10.25
SECOND AMENDMENT TO LEASE
This Second Amendment to Lease is attached to and made part of that certain
Lease dated July 1, 1997 by and between Cheyenne Investments, LLC, a Nevada
Limited Liability Company, ("Landlord") and MGC Communications, Inc., a Nevada
Corporation ("Tenant").
The above mentioned Lease is amended as follows:
ADDITIONAL RENTABLE AREA
1) Approximately Three Thousand Three Hundred Thirteen (3,313) square
feet of Rentable Area, located in building B, Suite 7, at 3291 N.
Buffalo Drive, Las Vegas, Nevada 89129.
2) The Base Monthly Rent for the additional square footage is Five
Thousand Six Hundred Three and 11/100 Dollars ($5,603.11).
IN WITNESS WHEREOF, Landlord and Tenant have signed this Second Amendment to
Lease this 29th day of December, 1998.
LANDLORD: TENANT:
Cheyenne Investments, LLC MGC Communications, Inc.
A Limited Liability Company A Nevada Corporation
By: /s/ GEORGE K. CONNOR /s/ NIELD J. MONTGOMERY
- ------------------------------- -------------------------------
Title: Manager Title: President & CEO
------------------------ ------------------------
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Subsidiaries of MGC Communications, Inc. are as follows:
MGC Lease Corporation, a Nevada Corporation formed February 5, 1998
MGC License Corporation, a Georgia Corporation formed November 24, 1998
MGC LJ.Net, Inc. a Nevada Corporation formed January 22, 1999.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K, into the Company's previously filed
Registration Statement File No. 333-60141.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
March 22, 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 related to the
financial statements of MGC Communications, Inc. for the year ended December 31,
1996 included in your annual Form 10-K report for the year ended December 31,
1998.
KPMG LLP
Las Vegas, Nevada
March 23, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 11,886
<SECURITIES> 112,442
<RECEIVABLES> 6,466
<ALLOWANCES> (257)
<INVENTORY> 0
<CURRENT-ASSETS> 49,102
<PP&E> 122,935
<DEPRECIATION> (6,555)
<TOTAL-ASSETS> 252,119
<CURRENT-LIABILITIES> 31,896
<BONDS> 156,693
0
0
<COMMON> 17
<OTHER-SE> 63,243
<TOTAL-LIABILITY-AND-EQUITY> 252,119
<SALES> 18,249
<TOTAL-REVENUES> 18,249
<CGS> 17,129
<TOTAL-COSTS> 40,244
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,064
<INCOME-PRETAX> (32,065)
<INCOME-TAX> 0
<INCOME-CONTINUING> (32,065)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (32,065)
<EPS-PRIMARY> (2.26)
<EPS-DILUTED> (2.26)
</TABLE>
